When the stock market is choppy, the first place investors look to park their money is a safe haven. This could be in the form of government-backed debt. A gilt fund invests in loans given to the Central and State Governments. Being government-backed, there is minimal risk of default as the government is the borrower.
The Zero-Default Illusion: What Makes a Gilt Fund Safe?
What investors do not realize is that “safe” does not mean “static”. Gilt funds are extremely sensitive to interest rates, as any change in the rates would impact the existing bond prices in the opposite direction. If the RBI cuts rates, prices of existing bonds would rise, thus increasing the NAV of these gilt funds. Similarly, if rates rise, the bond prices would fall. This is the biggest risk factor that an investor in these gilt funds should be aware of. If the duration of the bonds in the fund is high, the impact would be higher.
The Interest Rate Seesaw
An investor cannot blindly park money in these gilt funds like they would in a fixed deposit. These funds behave most like fixed deposits during a falling interest rate scenario. Thus, if an investor were to time the market correctly, they could benefit from both the coupon payments as well as the capital gains from the rise in bond prices. However, if an investor were to enter the fund when interest rates are on the rise, the value of their units might stagnate or dip until the cutoff point.
The Practical Path: How to Invest in Mutual Funds Like These
If you have decided this fits your portfolio, the question becomes how to invest in mutual funds like these without getting tangled in paperwork. Investors in such schemes do not need a separate government securities account to invest. An investor can use a mutual fund platform like Angel One to go through the process.
Here’s how the process works in practice:
- Log in to the Angel One app with your registered mobile number
- In the Mutual Funds section, search for gilt funds.
- Compare the expense ratios for the different gilt funds and also their maturity profiles. The lower the expense ratio, the higher the returns that goes to the investor.
- Decide whether they want to go with a lump sum or a Systematic Investment Plan (SIP) for investing in the chosen gilt fund.
- Pay the amount due through UPI or net banking, and they will be allotted the requisite number of units.
The Tax Reality Check for Debt Funds
One reality check that investors must consider before investing in such products is the tax implications for debt funds. Investors in gilt funds should ideally look at a 3 year holding period as anything sold before that would be added to their income tax. For long term gains, a 20% tax would be levied on the capital gains with indexation benefits. Investors in the highest tax bracket often find these types of funds more tax efficient than fixed deposits.
The Bottom Line
Gilt funds are not meant for the aggressive investor. They are a tool for preservation and, if timed right, appreciation. People who wish to diversify their assets away from equities and decrease their risk of default can include these funds to their portfolio.