Gilt With 10 Year Constant Duration Mutual Funds

What is Gilt With 10 Year Constant Duration Mutual Funds?

Gilt funds are mutual fund schemes that invest in government securities. These securities are issued by the Reserve Bank of India (RBI) on behalf of the Central Government to raise funds. The gilt funds are safe investments as the investments are made to the government. Also, the RBI determines the interest rate for these securities. 

Gilt funds with 10 year constant duration are open-ended debt mutual funds. According to SEBI, these funds invest at least 80% of their total assets in government securities where the Macaulay duration for the portfolio is 10 years or more. The objective of gilt with 10 year constant duration mutual funds is to deliver returns by investing in government securities of the highest credit quality. This fund has a negligible risk as the government is liable to pay back the money to its investors. 

The RBI changes the repo rate in the market, which affects the interest rate of these funds. Therefore, the gilt with 10 year constant duration mutual funds perform well in the falling interest rate scenario. They could offer higher returns in comparison to other debt funds. Also, its sovereign rating makes it a safe investment instrument. Nevertheless, the returns generated from these funds can fluctuate depending on the pattern of interest rates in the country. 

While dealing in gilt funds, the fund’s managers follow a passive approach as they do not actively manage lending duration irrespective of rate changes, and the portfolio duration is maintained constantly at 10 years. Also, the fund manager trades in and out gilt securities with different maturities. This helps them to look for future interest rate movements in the market. Based on this, they invest in short term or long term securities accordingly. 

Advantages of Investing in Gilt With 10 Year Constant Duration Mutual Funds

The following are the advantages of investing in gilt with 10 year constant duration mutual funds.

• Safety: Gilt funds are one of the safest forms of mutual fund investments as they invest 80% of their portfolio in government securities issued by the RBI. Hence, they have the obligation for repayment of both principal and interest component to the public. Also, this ensures that there are zero risks to the portfolio. Furthermore, gilt funds are safer than any other debt funds.
• Low Risk: Generally, the government pays back the money it borrows from the public. Hence, the gilt funds have zero risks associated with them. Even though there is low default risk, they do carry interest rate risk. Also, the returns of the fund are affected by the interest rate movements. 
• Investment Duration: As the name suggests, gilt with a 10 year constant duration comes with a 10 year lock-in period, which means that the Macaulay duration of the portfolio is fixed for 10 years. Therefore, investors looking for long term investment duration with zero risks can opt for gilt funds in India. 

Limitations of Investing in Gilt With 10 Year Constant Duration Mutual Funds

Interest Rate Risk: Gilt funds with 10 year constant duration have a higher interest rate risk than other debt funds. These funds are sensitive to interest rate fluctuations as it invests in government securities with long Macaulay duration. Therefore, these funds are affected when the interest rates rise as the bond prices fall, leading to negative returns. 

Who should Invest in Gilt With 10 Year Constant Duration Mutual Funds?

Gilt with 10 year constant duration mutual funds is suitable for investors looking for long term fixed income investment. Also, these investors seek minimum risk from their investments as the fund invests in government bonds which are the safest instruments. Since these funds invest in government bonds with a fixed duration of 10 years, they may offer higher returns in a falling interest rate scenario. 

Moreover, the government securities that the fund invests in has a sovereign rating. Thus, it does not default on the principal and interest payments on government bonds. Investors with low risk tolerance levels can invest in gilt with 10 year constant duration mutual funds. 

Investment in gilt funds can help investors diversify their portfolio. Also, it may offer higher returns in comparison to bank fixed deposits. Furthermore, it offers tax-efficient returns compared to fixed deposits for investors in higher income tax brackets. However, as per the Finance Bill 2023, from April 1st 2023, capital gains from gilt funds will be taxed as per the investor’s IT slab rate. Overall, proper financial planning is required before investing in gilt mutual funds. 

Things To Consider Before Investing in Gilt With 10 Year Constant Duration Mutual Funds

• Risk: Gilt with 10 year constant duration has no credit risk as the government backs these securities. However, these funds have exposure towards interest rate risk. During the rising interest regime, the NAV of the fund falls sharply. Hence, one must check the fund’s NAV before investing in these funds. 
• Returns: Historically, these funds have been earning relatively higher returns. However, mutual funds do not guarantee returns as they are subjected to market risks. For gilt funds, the returns are based on the interest rates announced by RBI. Hence, these funds generate higher returns in a falling interest rate scenario as these funds invest in bonds with longer residual maturity. (Macaulay duration)
• Investment Tenure: Investors who have low risk tolerance levels looking to invest for a longer duration with at least 10 years can consider investing in gilt with 10 year constant duration mutual funds. 
• Investment Objective: If the investment objective is to accumulate stable returns for a longer duration with no credit risk, gilt funds are the best available schemes. Moreover, they are the safest investment option in a falling interest rate scenario and the right choice to earn good returns. 
• Expense Ratio: Every mutual fund has certain charges associated with it, like fund management fee and other related expenses. SEBI has capped the expense ratio at 2.25% for debt mutual funds to protect the interest of investors. Also, the operating cost is fund specific and depends on the fund manager’s investment strategy. Hence an investor must consider the expense ratio while performing investment planning and setting goals.
• Taxation: The taxation of gilt funds with a 10 year constant duration is similar to debt mutual funds. The capital gains of the fund depend on the investment tenure. Short term capital gains tax (STCG), according to the investor’s income tax slab rate, is applied if the investment is redeemed before three years. Similarly, long term capital gains (LTCG) are applicable if the holding period is beyond three years, applicable at 20% with indexation. 
  From April 1st 2023, capital gains from gilt fund investment will be taxed as per the investor’s income tax slab rate, irrespective of the investment tenure. Thus, gilt funds will no longer have the LTCG benefit.

Conclusion

Some years have been favourable for gilt funds in India due to the falling interest rate regime. For instance, 2019 was a favourable year where the funds gave double-digit returns. However, the interest rates movements are not unidirectional. There are chances of negative returns as they are highly volatile. Therefore, investors have to proceed with caution based on the interest rate cuts. 

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