What are Gilt Funds – meaning, features, risk & returns

If you are looking for low-risk mutual funds that can offer you benefits like growth, diversification, etc., you have plenty of room for choice. There are 16 types of debt funds as per the Securities and Exchange Board of India (SEBI) guidelines on the categorisation and rationalisation of schemes. Out of these, gilt funds can be ideal for conservative investors looking for a safe and reliable way to invest money. In this article, let's take a closer look at what gilt funds are, how they work, and the potential benefits of investing in them.

What are gilt funds, and how do they work?

 A gilt fund is a type of mutual fund that primarily invests in government securities. As per the gilt fund meaning, these funds carry minimal to no credit risk, as they are backed by the Government of India. Fund managers allocate assets across short-term and long-term government bonds. Gilt fund returns are influenced largely by interest rate movements — they tend to rise when rates fall and vice versa.

Gilt funds are mutual funds that invest primarily in government securities (G-secs) or bonds, which are considered to be very low risk. They are open-ended schemes and do not invest in corporate bonds.

To understand how gilt funds work, it is essential to know that when the Government of India needs money, it borrows money from the Reserve Bank of India (RBI). The RBI further borrows money from other entities such as insurance companies and banks. In return, the RBI issues G-secs with fixed tenures. Gilt funds subscribe to these securities. At maturity, the gilt fund returns the G-secs and gets money in return.

There are two types of gilt funds. The first, known as gilt funds, invest at least 80% of their total assets in government securities. The second type, known as gilt funds with a ten-year constant maturity, invest 80% of their total assets in G-secs for ten years.

Now that you know a bit about gilt funds, find out the benefits of investing in them.

Benefits of investing in gilt funds

One of the key advantages of a gilt fund is the high level of safety it offers, as there is no risk of default. These funds are also known for their transparency, given they invest in sovereign papers. Moreover, gilt fund returns have the potential to deliver capital appreciation during periods of declining interest rates. For conservative investors, gilt mutual funds offer a credible alternative to other debt instruments.

• Stable returns: Gilt funds have the potential to provide steady returns when interest rates are low.
• Opportunity to invest in G-secs: Gilt funds offer exposure to G-secs that is not possible otherwise. You can invest in G-secs through these funds and diversify your portfolio.
• Low risk: G-secs carry minimal credit risk as they are backed by the government. As a result, the gilt funds carry low risk.

Gilt funds offer many benefits. However, when investing in them, several essential factors must be considered so that you can make an informed investment decision.

Things to consider when investing in gilt funds

While gilt mutual funds are relatively safe in terms of credit risk, they are sensitive to interest rate movements. Investors must account for duration risk, especially in long-tenure bonds. It's also important to consider the investment horizon, as gilt fund returns can be volatile in the short term. A longer investment period allows better absorption of interest rate fluctuations.

• Interest rates:As gilt funds primarily invest in G-secs, they are sensitive to interest rates. When interest rates rise, the value of the bonds held by the fund falls, which can lead to a decline in the fund's NAV. On the other hand, when interest rates fall, the fund's NAV rises.
• Expense ratio:Gilt mutual funds charge an expense ratio to cover their operational expenses. It is important to compare the expense ratios of different gilt funds because they may differ across funds.
• Investment horizon:Gilt funds are typically recommended for investors with a medium- to long-term investment horizon.
• Taxation: Profits from gilt funds are subjected to long- and short-term capital gains tax depending on their holding period. Gains from funds held for more than three years are taxed at 20% plus indexation, whereas gains from funds held for less than three years are added to your taxable income and taxed accordingly.

Note: Indexation adjusts the cost of an asset for inflation to reflect its actual value over time. This lowers the tax liability as you pay tax on the gains you make after adjusting your investment cost for inflation.

Who Should Invest in Gilt Funds?

Gilt mutual funds are best suited for risk-averse investors who seek safety of capital and have a moderate to long-term investment horizon. Those who understand interest rate cycles and are not seeking instant gains may find gilt funds particularly useful. They may also serve well in times of falling interest rates, where the potential for gilt fund capital appreciation increases.

How to Invest in Gilt Funds?

Investing in a gilt fund is simple and accessible through online platforms, mutual fund distributors, or directly via an Asset Management Company’s website. Before investing, one should evaluate the fund’s average maturity, duration risk, and past performance. Many gilt mutual funds are available as part of both regular and direct plans, giving investors flexibility in cost and access.

Tax Implications of Gilt Fund Investments

The tax treatment of gilt mutual funds is in line with debt mutual funds and all gains, irrespective of the holding period, are taxed as per the investor’s income tax slab. Investors must be mindful of these rules while evaluating post-tax gilt fund returns.

Conclusion 

Being a type of debt mutual fund, gilt funds can be suitable for conservative investors looking for low-risk investments that offer stable returns. You can also consider other low-risk options like passive debt funds, long-duration funds, etc. Just remember to understand the pros and cons of all options and research well before picking a fund.

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