Are Gilt funds risk-free?
In the last one-year, gilt funds have given double-digit returns of 10.45 per cent on a trailing basis. This has made a lot of investors to turn to gilt funds. It can be easily witnessed from the data of inflows, published by the Association of Mutual Funds in India (AMFI).
As we can see, the rise in inflows has been witnessed since March 2020, which continued till July 2020. However, in the month of August 2020, it witnessed a net outflow. This was amid the rising yields on government bonds. Now the point is, whether the government securities are risk-free?
Many a time, people fail miserably due to the lack of a proper understanding of the product and its underlying market. As far as risk is concerned, there are two major risks in the bond market viz. interest rate risk and credit risk. When we talk about debt funds such as corporate bond funds, short-duration funds, long-duration funds, dynamic bond funds, etc. all of them are prone to the interest rates as well as credit risk. It is only gilt funds and gilt funds with 10-year constant maturity that are not prone to credit risk. However, they are still very much prone to interest rate risk. In fact, as most of the gilt funds invest in government securities with a longer duration, they are more sensitive to interest rates. Hence, it is wrong to assume that the gilt funds are risk-free. They do possess interest rate risk.
When to invest in them?
Now the natural question would be as to when to invest in gilt funds? The best time to invest in gilt funds is when the economy is moving towards the slowdown. In such times the Reserve Bank of India (RBI) cuts key rates to manage liquidity in the economy. It is this time when you would benefit from investing in gilt funds. In fact, the current success in the performance of gilt funds was due to the 115 basis points of the rate cut by RBI. Thus, you need to consider yield curve, inflation, bank liquidity, RBI’s monetary policy, etc. before investing in gilt funds.
If you ask about the present scenario, then it is expected that RBI is not going to cut the rates further, despite taking an accommodative stance and inflation rising beyond its medium-term range of 2 per cent to 6 per cent. Hence, it is better to avoid investing in funds betting on long-duration papers. At present, it makes more sense to stick with funds investing for short-duration papers.