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Invest in gilt funds for the medium term

Tania Kishore Jaleel / Mumbai 09 Aug 12 | 12:19 AM

With the Reserve Bank of India (RBI) leaving key rates unchanged in its monetary policy review last week, debt continues to look like a good proposition for risk-averse investors. And, gilt funds, which invest in government securities (G-Secs), have done quite well in last quarter.

According to the latest CRISIL Mutual Fund Rankings, released for the quarter ended June, gilt funds were the best performers across the 22 mutual fund categories ranked.

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Gilt funds returned 3.1 per cent over the quarter, outperforming both equity and other debt-oriented categories. Equity funds returned 1.39 per cent during the quarter, 1.93 per cent by the Nifty and 1.12 per cent by the S&P CNX 500 Equity Index, said the report.

Fund category returns for quarter ended June 30, 2012 (%)
Gilt funds 3.10
Income funds 2.66
Nifty 1.93
S&P CNX 500 1.12
Equity Index                  Source: CRISIL

Since G-Secs are sovereign papers, they do not expose investors to credit risk. Conventional debt funds invest in debt instruments across the board, but gilt funds invest only in government bonds.

“The gilt fund category does well when interest rates fall. These funds are a good bet, if you have a medium term view (one to two years). That is, if you are of the view that interest rates will fall in the next year or two.

The fall in interest rates will also depend on factors like inflation, government’s borrowing programme and other external factors. Gilt funds are a good avenue to take advantage of falling rates. It will be the instrument which will give one best returns once the rates start to fall," said Jiju Vidyadharan, director, Funds and Fixed Income Research, CRISIL Research.

However, even though gilt funds have given the best returns, this did not translate into a rise in the assets under management (AUM) of these funds. “The category AUM has however, not seen a rise. This could be because of investor uncertainty on the pace of interest rate decline," explains Vidyadharan.

The yields of the G-Secs that gilt funds invest in have been very volatile. This is one of the reasons experts cite for not many people taking a liking towards gilt funds, as these are very volatile. People favour more stable investment options like income funds.

According to the CRISIL report, the majority of investor interest was towards income funds (especially dynamically managed bond funds), which witnessed a growth of 33 per cent in AUM for the June quarter to Rs 10,446 crore from Rs 7,812 crore. This category returned 2.7 per cent during this period.

Gilt funds are ideal for those who want more safety for their investments or are risk-averse and, at the same time, are looking for reasonable returns on their money. Mahendra Jajoo, director and CIO (fixed income) at Pram-erica Mutual Fund suggests that one should invest in tranches to avoid over-exposure and associated risks.

Factors such as fiscal deficit and the country’s debt burden weigh on the performance of G-Secs and, hence, gilt funds, adds Jajoo.

Investments in gilt funds are subject to interest rate risks. When interest rates rise, prices of G-Secs fall, adversely impacting the performance of gilt funds. Typically, higher the fund’s average maturity, higher the volatility. Another disadvantage is that these are highly illiquid. These funds invest in G-Secs, which are not actively traded.

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