Gilt Funds: What are Gilt Mutual Funds & How do they work?
Credibility is an important factor in almost all aspects of our lives. For instance, we prefer to take health advice from a trustworthy doctor, buy gold from a reliable jeweller, and try to dine out at restaurants that have a reputation for hygiene and cleanliness.
Shouldn’t we carry the same safety precautions when lending our hard-earned money? Absolutely. Lending money to a non-dependable source can be dangerous and incur losses. Do you know who is considered one of the most credible borrowers? It’s the government, as it is not likely to default.
“Wait, a government borrows money?”
Well, yes. The government requires funds to undertake various development projects and to meet other financial requirements. So, it issues securities by borrowing these funds. A mutual fund scheme that invests in these government-issued securities is known as a Gilt Mutual Fund.
Now that you know gilt funds' meaning, let’s see how they work.
How do Gilt Mutual Funds work?
When the government requires funds, it approaches the Reserve Bank of India (RBI). The RBI then issues bonds with fixed maturity to raise these funds. When the bond matures, the money is returned to the investors. A gilt fund enables retail investors to invest in various government securities in one go.
Benefits of investing in gilt funds
Investing in gilt funds can provide the following benefits.
1 Exposure to government securities
Retail investors may easily invest in such securities by investing in a gilt mutual fund.
2 Minimal Credit Risk
As these securities are issued by the government, which has responsibility for national welfare, the credit risk of gilt funds is minimal.
3 Low liquidity risk
These securities can be traded easily in the secondary market.
4 Tax efficient
As gilt funds are debt mutual fund schemes, the returns generated from gilt funds can avail indexation benefits if the holding period is more than 36 months.
Things to know before investing in Gilt Funds
Gilt mutual funds may carry less risk than the equity market, but they are subject to interest rate risk. For example, let’s assume the current interest rate is 7% So, the gilt funds may offer a similar rate of interest. Now, if the rates decrease to 5%, the demand for the bond that pays 7% interest will increase. As in, investors will be ready to pay more for a bond that pays a higher rate of interest.
Consequently, if the interest rate increases to 9%, the demand for a bond paying 7% will decrease; here, the investors may also prefer a bond paying a higher interest rate. As a result, the bond that offers 7% interest may be sold at less than its actual price.
Who should invest in gilt funds:
1 Investment Horizon
Gilt funds are suitable for investors with a medium to long-term investment horizon, typically over 3 years.
2 Investment Objective Investors whose main objective is safeguarding their capital while making the most of interest rate changes can consider investing in gilt mutual funds.
To sum up, gilt mutual funds invest in high-quality government securities with minimal credit risk but are subject to interest rate risk.