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What are Gilt Mutual Funds?

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What are Gilt Fund?

The term 'Gilt' originated to connote British government certifications that had gilded edges. Gilt funds going forward were defined as mutual funds that predominantly invest in government securities (G-Secs). These funds are ideal for retail investors as they allow them an opportunity to directly invest in Government papers, which otherwise are dominated by institutional investors. The basic purpose of investing in Gilt funds is to generate returns at negligible risk as it is highly unlikely that the government will default on the debt raised by it.

Returns from Gilt funds are highly dependent on the change in interest rates as there is an inverse relationship between bond prices and interest rates. Hence, when the interest rate falls, prices of government securities go up, benefiting the performance of Gilt funds and vice versa. Government securities include central government dated securities, state government securities and treasury bills.

Performance Gyrations

 

Since 2009 the returns on these funds have been far from impressive. Around 2009, stocks begun recovering, and there were more lucrative assets to which investors flocked albeit to assets with greater risk. A look at the performance table clearly brings out the gyration in annual returns delivered by Gilt funds. After delivering double digit returns of 27.50% in 2008, the average long term Gilt fund actually delivered a loss to its investors in 2009. However, at the end of 2012 the category average stood at 10.21%. This is because the Reserve Bank of India (RBI), the country's central bank, which since 2010 had been relentlessly raising interest rates owing to rising inflation, has done an about turn, triggering off the process of slashing rates. Since April 2012, the Reserve Bank of India has cut interest rates by 100 bps. Moreover, to improve the liquidity condition, the central bank has reduced the Cash Reserve Ratio by 150 bps to 4.00% from 5.50% in January 2012. Year to date (as on April 29, 2013), the average Gilt fund delivered 13.83% simple annualized return.

Gilt funds witnessed appreciation in their net asset value as the interest rate cycle has already peaked and rates are coming down, as a result investors are lured to invest in Gilt funds. This is evident by the corpus mopped up by Gilt funds over the last six months. The Assets under Management (AUM) in these schemes increased to Rs. 8,074 crore in March 2013 from Rs. 3,356 crore in September 2012.

Risk

Before committing your money it is imperative for an investor to be absolutely clear about the risks associated with the investment. While it is true that risk in government securities is minimal, there is always the risk of interest rates changing in the economy. When interest rates move up, the price of a bond moves down. Apart from this there are other factors that can push bond prices down. As a lay investor one could keep a look out for certain key indicators to follow the trends in Gilt funds. Cash Reserve Ratio (CRR) and Repurchase rate (Repo) are the most commonly mentioned terms, an increase in either one would bring bond prices down and vice-versa. Bond prices are also sensitive to inflation as the central bank is likely to increase the CRR and Repo lest inflation should spiral out of control. Higher inflation is viewed as a negative and can pull bond prices lower. Apart from this, an increase in government borrowing is also not welcome by traders, off late an increase in government borrowings has been a big dampener to investor confidence. Call rates which are an indicator of short term liquidity in the market again influence bond prices indirectly, if call rates are increasing, traders and banks are likely to sell government securities held by them, triggering a drop in prices. Also instead of bond prices you will find references to the 'yield' of a particular instrument, when bond prices fall the yields increase and vice-versa.

While most economic advisors and experts believe that the central bank will continue reducing interest rates during 2013, a spike in inflation could de-rail such rate reductions. Hence investors who have committed their money to Gilt funds, should keenly watch out for the direction that inflation rates take.

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