What are Gilt Funds – Best Gilt Mutual Funds for 2021

What are Gilt Funds – Best Gilt Mutual Funds for 2021 Gilt Funds are a type of debt mutual funds. Gilt funds invest in government securities issued by central and state governments. Gilt mutual funds are considered to be one of the safest types of debt funds in India. They carry zero default risk as they are backed by the government. Gilt funds have been in news in 2020-21 as the top 5 gilt funds have generated an average 1-year return of 10.51%! Such high returns have resulted in huge retail interest in gilt funds. But before investing in best gilt mutual funds, you must know the basics of gilt funds. In this article, we will explore everything about gilt mutual funds in India.

What are Gilt Funds? – Meaning of Gilt Mutual Funds

As per the Securities and Exchange Board of India, SEBI, ‘gilt funds are mutual funds with minimum 80% of its assets in government securities’. Gilt mutual funds invest in bonds and other fixed income securities issued by central and state governments.  Gilt mutual funds invest in two types of government securities: 
  • Government securities with fixed maturity (10 year constant maturity)
  • Government securities with varying maturities.  
Gilt mutual funds are extremely safe since they are backed by the government. 

The Reason Behind the Name – Gilt Funds

Gilt Funds originated in the United Kingdom. The British government would borrow funds from the public and issue physical bond certificates in return. These bond certificates would have a border of thin gold paint. Hence, they came to be known as ‘Gilt-edged’ certificates. Gilt mutual funds are also known as sovereign bond funds as they carry sovereign (government) guarantee. 

How Do Gilt Mutual Funds Work?

There are 3 parties to the working of Gilt Funds:
  1. The Government
  2. The Reserve Bank of India, RBI
  3. Mutual Fund schemes
The Government: Governments are always in need for funds. They might need money for infrastructural development, socio-economic growth or to manage fiscal deficit. To get these funds, the government approaches the RBI.  Reserve Bank of India, RBI: RBI is the central bank of India. But it also acts as a banker to the government. RBI collects money from pension funds, insurance companies, Banks etc on behalf of the government. In return, RBI issues ‘gilt securities’. These securities have a fixed maturity date and interest rates.  Mutual Fund Schemes: Mutual fund schemes invest in these securities on behalf of the unitholders. This way retail investors get to participate in the Indian gilt fund market. 

What are the Types of Gilt Funds?

There are two types of gilt mutual funds in India:
  1. Across maturities gilt mutual funds.
  2. Constant 10-year maturity gilt mutual funds.
Across Maturities gilt mutual funds: These funds invest in government securities across various maturities. They can invest in: 
  • Short term government securities (1-3 years)
  • Medium term government securities (3-5 years) 
  • Long-term government securities (10+years)
The fund manager composes the portfolio as per the current interest rate scenario.  Constant 10-year maturity gilt mutual funds: These funds invest in government securities with a fixed 10-year maturity period. The interest rate of 10-year government bonds is considered as a benchmark for all debt securities. 

What are the Risks of Gilt Mutual Funds?

Gilt mutual funds are debt funds. But unlike debt funds, gilt funds do not face credit risk or liquidity risk. The biggest risk faced by gilt mutual funds is Interest Rate Risk

Gilt funds and Interest Rates – a detailed explanation

Gilt funds and interest rates have an inverse relationship.
  • Interest rates increases = Yield on gilt securities falls
  • Interest rates decreases = Yield on gilt securities rises
Let us understand the relationship between gilt securities and interest rates with a simple example: Suppose the current interest rate is 6%. RBI issues Bond A giving 7% interest. As expected, investors invest in Bond A. After a year, the interest rates fall to 5%. RBI issues new Bond B giving 6% interest.  As expected the demand for bond A will go up because it is giving a higher interest rate.   When the demand increases, the price of Bond A will increase. This will cause the yield on Bond A to fall.  Similarly, when RBI increases interest rates, the demand for older bonds (carrying lower interest rate) falls. This reduces their demand and their prices fall. As the price falls, the yield rises.  A falling interest rate is good for gilt mutual funds. This is the reason why gilt funds have been providing high returns in the last 1 year.

Why are Gilt Funds Rallying? - Reason Behind Gilt Fund’s Rally

Gilt mutual funds have been one of the top performers in 2020. Top gilt mutual funds generated a 1-year return of more than 12%! The reason behind this was RBI’s falling interest rate regime. To help the economy during the COVID19 pandemic, RBI reduced interest rates to multi-year lows. Reduced interest rates meant that old bonds were in high demand and their yields increased. Also, since gilt funds are ‘guaranteed’, investors preferred them over equities during the pandemic uncertainty. 

Who Should Invest in Gilt Funds?

Normally, low-risk investors invest in debt mutual funds for their short-term financial goals.  But this is not true for gilt mutual funds.  Gilt mutual funds are highly reactive to interest rates. The Net Asset Value, NAV of gilt mutual funds experiences high fluctuations. Hence, only high-risk investors should invest in gilt mutual funds. Gilt mutual funds are suitable for investors who understand interest rate movements. But such investors need to time their entry and exit to make decent profits.

Who Should Not Invest in Gilt Funds?

Low-risk or conservative investors should not invest in gilt funds. Investors with a short-term investment horizon should also avoid gilt funds.  Here is an example of how volatile gilt funds can be:  SBI Magnum Gilt Fund is one of the top gilt mutual funds in India. It’s Assets under Management, AUM is Rs 4,396 crores.  The fund gave a return of 28.24% between 31.03.2001 to 02.04.2002.  But the fund also fell by 15.42% between 2nd January 2009 and 4th Jan 2010. This proves that gilt funds are extremely volatile. Timing is everything when investing in gilt funds. Since retail investors are not expert enough to time the market, they should stay away from gilt funds.

Things to Consider before Investing in Gilt Mutual Funds

1. Average Maturity: Average maturity shows the average maturity of papers held by the gilt fund. Investors should try to match their goals to the average maturity of gilt funds.  2. Yield to Maturity: Yield to maturity shows the return the fund will generate if the underlying portfolio is held till maturity. This is a good indicator for investors to set their return expectation. But the yield to maturity does change as the fund manager buys and sells bonds. 3. Modified Duration: Modified duration measures the sensitivity of the bonds to interest rate changes. A high modified duration means high volatility when interest rates are increased or decreased. 4. Risk – Reward Ratios: Ratios such as Standard Deviation, Sharpe, Beta and Alpha are also important while investing in gilt funds.
  • Standard Deviation helps you measure the volatility of the fund. A high standard deviation fund is suitable for high-risk individuals only.
  • Sharpe: A high Sharpe ratio than peers means the fund has generated high risk-adjusted returns.
  • Beta: A beta of more than 1 indicates that the fund will have wide ups and downs compared to the benchmark.
  • Alpha: Alpha shows your funds’ outperformance over the benchmark.
5. Your Financial Goals: Investors should invest in gilt mutual funds only after analysing their financial goals. Investors should not invest in long term gilt funds for short-term goals. Investors can consider corporate bond funds or Banking & PSU Funds for short-term goals. 

How are Gilt Mutual Funds Taxed? 

Gilt mutual funds invest in government ‘debt’ and hence follow debt taxation.  The holding period for gilt mutual funds is 36 months or 3 years. 
  • If you redeem before 3 years, then short term capital gains tax of 15% is applicable. 
  • If you redeem after 3 years, then long term capital gains tax of 20% with indexation is applicable. 

List of Best Gilt Mutual Funds in India for 2021 – Across Maturities Gilt Funds

Best Gilt Mutual Funds - Across Maturity 1 Year 3 Years 5 Years 10 Years Average Maturity
L&T Gilt Fund 7.51% 8.22% 8.20% 9.18% 6.89 years
Aditya Birla SL Government Securities Fund 8.56% 9.76% 10.09% 9.81% 8.79 years
IDFC Government Securities - Investment Plan 9.13% 11.14% 9.74% 9.98% 7.01 years
HDFC Gilt Fund 7.00% 7.84% 8.32% 8.26% 8.34 years
Kotak Gilt Fund 9.48% 9.88% 9.26% 8.85% 11.01 years
**This is simply the list of best gilt funds. This is not investment advice.

List of Best Gilt Mutual Funds in India for 2021 - 10-year Maturity Gilt Funds

Best Gilt Mutual Funds - 10 Year Constant Maturity 1 Year 3 Years 5 Years 10 Years Average Maturity
ICICI Prudential Constant Maturity Gilt Fund 9.97% 11.65% 10.29% - 9.41 years
IDFC Government Securities Fund - Constant Maturity Plan 8.79% 12.24% 10.46% 9.52% 9.19 years
SBI Magnum Constant Maturity Fund 7.78% 10.45% 9.92% 9.78% 9.52 years
DSP 10 Year G-Sec Fund 8.96% 9.69% 8.88% - 9.43 years
**This is simply the list of best gilt funds. This is not investment advice.

Final Thoughts

Gilt mutual funds are an excellent replacement for bank FDs. They are equally safe and offer much higher returns than bank FDs. But gilt mutual funds are suitable for only high-risk investors. They carry extremely high interest rate risks. Low – Medium risk investors should consider investing in Banking & PSU Debt funds. These funds invest in banks and PSUs which are under RBI and Government guarantee. But when selecting a banking and PSU Debt fund, only invest in funds with more than 80% in AAA rated papers. But simply knowing the names of best gilt funds is not enough. You also need to know when is the best time to enter and exit gilt funds.  This expert input is provided by RankMF. RankMF is India’s best mutual fund research and investment platform.  RankMF helps you invest in the right funds at the right time. This helps in profit maximisation.  To maximise your profits, open a FREE RankMF account today and start investing in the best gilt mutual funds in India.

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