Gilt funds: Should you invest?
Gilt funds are believed to bear little to no credit risk because the government issues the underlying securities.
It can be confusing to select which category is safe when it comes to debt mutual funds. Retail investors cannot purchase certain government securities directly. Individuals can only invest in gilt funds to acquire exposure to such government securities.
Gilt funds bear little to no credit risk because the underlying securities are issued bu the government. The government may never default on its obligations, making gilt funds an attractive option for risk-averse investors. As per Value Research data, gilt fund has given a return of 4.47%, 9.46%, and 6.98% over one, three, and five years.
How do they work?
When a state or central government needs money, seeks financial assistance, they approach the RBI. Following that, the RBI collects funds from insurance companies and banks and lends them to the government. In exchange, the RBI issues fixed-term government securities. These securities are subscribed by gilt funds. Once the security matures and the fund receives a payout, the fund returns it.
These funds earn interest by taking on interest rate risk. Due to the government’s backing, the credit risk is essentially non-existent. The relationship between interest rates and the prices of government securities is inverse. In other words, as interest rates rise, the value of government bonds declines. It has a direct effect on the way it performs.
Factors to consider before investing
Risks: Unlike corporate bonds, gilt funds do not carry credit risk and are the most liquid financial asset available. However, gilt funds do expose investors to interest rate risk. When interest rates rise, the net asset value (NAV) of gilt funds typically falls sharply.
Returns: Gilt fund returns are not guaranteed and may fluctuate depending on the interest rate regime. As a result, investors are urged to invest during periods of declining interest rates.
Expense ratio: Gilt funds carry an expense ratio, an annual fee that comprises associated expenses and the fund manager’s compensation. This is expressed as a percentage of the fund’s average assets under management.
Maturity period: If you are considering investing in gilt funds, your investment horizon should be at least 3-5 years, as the average maturity of a gilt fund portfolio is approximately that long.
Investment objectives: If your investment objectives are medium-term, you can invest in gilt funds and observe how interest rate volatility can work in your favour. If you’re searching for a quick way to accumulate wealth during a period of market slump, you can select reasonably safe gilt funds.