Are Gilt Funds Attractive Now?
(This is for information purposes only. This should not be construed as a recommendation or investment advice even though the author is a CFA Charterholder. Please consult your financial adviser before taking any investment decision. Safe to assume the author has a vested interest in stocks / investments discussed if any.)
(A follow up blog dated 05Mar2024 on how gilt funds performed in the past two years is available here)
Global bond yields have been surging since the start of 2021, driven mainly by higher inflationary expectations across the globe and in anticipation of inevitable increase of interest rates by central banks.
For example, the 10-year US Treasury note yield has risen by almost 200 basis points since January 2021; from about 0.93 per cent at the end of December 2019 to 2.90 per cent now (close 22Apr2022). More alarmingly, the 10-year Treasury yield has spurted by 140 basis points (or, 1.40 percentage points) year-to-date.
Indian Bond Yields
In India too, the 10-year government bond yields have been rising since July 2021. Since the start of 2022, the 10-year benchmark G-Sec yield has spiked by 72 basis points to 7.17 per cent now. In the past one year, the increase in yield is about 115 basis points (or, 1.15 percentage points).
Table 1: 10-year G-Sec yield graph for 25-year period > 
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I've written, over the years, comprehensively about Indian bond markets. If you're interested to know more about them, here are the links:
How to Invest in Gilt Funds?
Jittery bond markets - Is It Time to Invest?
Government Securities Market in India and Duration Management
Bond Basics - Know Everything About Bonds
Mutual Fund Asset Class Returns 31Mar2022
Saver's curse: Low Savings Rates and Liquid Mutual Fund Returns
India Macro Data 21Sep2021
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Let us now turn to our main discussion today: Are Gilt Funds Worth Investing Now? Before we answer the question, let us understand a little about gilt funds.
What are Gilt Funds?
They are mutual funds that invest in government securities. As per SEBI, India's capital market regulator, gilt funds should invest at least 80 per cent of the total assets in G-Secs (across maturity). G-Secs are short for government securities.
A certain portion of your money, depending on your risk-taking ability and asset allocation, you can allocate for gilt funds.
What are Gilt-edged Securities?
In the old days, the Bank of England (BoE) on behalf of the British Government used to print the certificates on paper containing gilded (golden) edges--hence the name gilt-edged securities. Obviously, this is no longer the practice. In fact, most of the government securities now-a-days are in electronic / demat form.
In India, the term ‘government securities’ includes all bonds and treasury
bills issued by the Central Government and state governments. These securities are normally referred to as "gilt-edged," as repayments of principal
as well as interest are totally secured by sovereign guarantee.
In the US, government securities are known as Treasury securities or simply Treasurys.
What is a Government Security?
"Government security" means a security created and issued by the Government for the purpose of raising a public loan or for any other purpose as may be notified by Government of India. They are simply called as government bonds in popular parlance.
Practically, the governments are coming to you with a begging bowl to raise money!
Where do Gilt Funds Invest?
Gilt funds typically invest most of the monies they collect from unitholders in government securities, with maturities ranging from 91 days to 40 years. They invest a large part in bonds issued by Government of India and a small part in bonds issued by State Governments.
However, depending on the liquidity of the instruments, gilt funds invest most of the money in G-Secs with maturity ranging from three to 15 years. If they expect interest rates to rise, they invest more money in shorter-term papers. And in a falling interest rate environment, they invest more money in long-dated bonds.
A small portion of the assets they may invest in Treps or Tri party Repos for short term purposes depending on the view of the fund manager. “Tri-party Repo” means a repo contract where a third entity (apart from the borrower and lender), called a Tri-Party Agent, acts as an intermediary between the two parties to the repo to facilitate certain services.
How Much Return Can I Expect?
As with any market-based financial products, there are no guaranteed returns, even though gilt funds carry little default or credit risk. However, if you go by the past record, investors that could hold gilt funds for periods longer than three to five years could expect to generate annualised return ranging from six to 10 per cent.
Of course, there is no guarantee that you will get this return. It's hard to predict the interest rate movements. Moreover, we don't know how commodity prices behave in future; as of now, they are highly volatile. India, as a net importer of important commodities, is at the receiving end of the commodity cycle now.
You may check the past returns of gilt funds using websites like, Value Research, Rupee Vest, MoneyWorks4Me and others.
In an earlier blog, I evaluated mutual funds returns in India, along with those of gilt funds. Here, you can also find annual returns of gilt funds between 2014 and 2021.
As per Value Research Online, the average returns delivered by regular plans of gilt funds are 2.1 per cent, 7.2 per cent, 6.3 per cent and 8 per cent for one-year, 3-year, 5-year and 10-year periods respectively (3-, 5- and 10-year returns are annualised--data as of 22Apr2022). Returns for direct plans will be higher. More on the difference between direct and regular plans here.
What are the Risks?
We generally don't expect Government of India or State Governments to default on the government loans. As such, gilt funds don't carry any credit or default risk, as the chances of government default are practically nil.
However, government bonds may lose their value if interest rates start inching up in the economy (interest rate risk). Bond yields move inversely to bond prices--meaning bond prices fall if interest rates rise and vice versa.
For a short term period of time, say, one month to 18months, gilt fund investors are likely to lose money. However, if they hold the funds for longer periods of time, say two to three years, the chances of losing money with gilt funds are practically zero. Of course, much depends on how long the rising interest rate cycle lasts.
According to media reports, the finances of the State Governments in India are not up to the standard right now. If you have a strong view on State Governments, you may avoid gilt funds that have invested in bonds issued by State Governments.
Are Gilt Funds Suitable for Me?
It depends. If you're risk-averse, conservative and if your time horizon is minimum two to three years for the spare money you have, you can invest in gilt funds.
Are Gilt Funds Attractive Now?
As we've seen in Table 1 above, the benchmark 10-year G-Sec yield movements are volatile. Between March 2020 and July 2021, Reserve Bank of India was able to keep interest rates and G-Sec yields artificially low even though CPI (consumer price index) inflation has been running high persistently above the RBI's upper-bound level of six per cent since September of 2019.
India's CPI inflation for March 2022 is 6.95 per cent--driven by high prices of food, vegetables, fuel and clothing. Ahead of 2024 General Elections, persistently high inflation is going to affect the dynamics of India's political economy. The future inflationary trajectory will depend on how PM Modi government will react to rising inflationary expectations ahead of the 2024 elections.
Will political expediency trump sound economic management? The probability of the former is greater than the latter. As it is, the Central Government has got a large borrowing programme ahead of it. Much hope was kept on raising money from the IPO (initial public offer) of LIC of India. But media reports suggest that the government may pare the issue size of LIC IPO due to the current market upheaval.
The LIC IPO was supposed to have taken place in March 2022, but was postponed due to global turmoil brought on by Russia invading Ukraine.
Coming back to gilt funds, the 10-year benchmark G-Sec yield is 7.17 per cent now (close of 22Apr2022). The yield has risen by about 130 basis points in the past six months, putting downward pressure on the returns of gilt funds.
Depending on the actions of RBI, inflationary expectations, global developments and Indian government's needs, the government bond yields may harden (rise) further in the next one or two quarters. Of course, this is just my personal view. It's hard to predict interest rate movements.
One strategy here would be to invest in gilt funds at different levels of 10-year G-Sec yield--for example, one could start investing at 7.40 per cent yield; then at 7.60 per cent and up to 8.00 per cent yield level. Of course, you can change the strategy to suit your typical needs.
Once you invest between 7.40 per cent to 8.00 per cent yield level, you can remain calm for the next 18 to 30 months and take a call then. The investment here hinges on your view of interest rate cycle to a great extent.
In What Gilt Funds Should I Invest?
Let us say you've decided (if you have no expertise, you should consult your investor adviser before making any investments) to invest in gilt funds, the question then is in what funds should one invest.
I've curated a list of 13 gilt funds for the benefit of you. My selection is based on the funds' long-term track record, individual fund house comfort, size of the fund (with gilt funds, the higher the size of the fund, the better could be return prospects), fund manager experience and others. This is just for information purposes only. I'm not recommending them to any of you.
Table 2: Gilt Funds details (please click on the image to view better) > 
Table 3: Gilt Funds annual returns (please click on the image to view better) > 
Summing up
Gilt funds carry moderate risk for investors with a time horizon of two to three years. Here, the assumption is that the RBI and the Government of India may not allow the 10-year G-Sec yield to reach levels above 7.80 or 7.90 per cent.
As I've argued for several years, the monetary and fiscal authorities in India are the biggest manipulators in bond and foreign exchange markets. Investors should be aware of these matters before investing in gilt funds.
Depending on your asset allocation, risk appetite and your view of the interest rate cycle, you can devise an investment strategy for your personal requirements and start nibbling gilt funds till the benchmark 10-year G-Sec reaches yield levels of 7.60 to 8.00 per cent. Happy investing all of you!
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Note: Even though this blog is dated 24Apr2022, I could finish editing the blog only by the morning of 25Apr2022.
Additional data:
Table 4: Gilt Funds' AUM data and CPI inflation >
As the table 4 below shows, even though inflationary pressures have been high since Sep2019, RBI has kept its LAF repo rate stubbornly low at 4 per cent since May2020.
This AUM table reveals a strange pattern of investors. The AUM of gilt funds doubled between Mar2020 (Rs 9,300 crore) and Dec2020 (Rs 18,600 crore)--during the period, gilt fund investors may pat themselves with earning decent return of 7 to 10 per cent. But the real action was in Indian equity market--for example, BSE 200 index jumped by 64 per cent in the nine-month period through Dec2020 in what is seen as one of the biggest bounce-backs in Indian stock market history.
You could argue this is all hindsight--but the point is playing safe all the time with our money may not help us in earning optimum returns for our assets. I'm not looking to 'maximise,' but just to 'optimise' my returns.
Table 5: Screenshot from Value Research > 
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BSE Broad and Sector Indices Returns
BSE Broad and Sector Indices Market Cap
When Will Foreign Investors Stop Selling Indian Stocks?
Rise of Retail Investors and Demat a/cs in India
Do Paint Stocks and Crude Oil Tango?
Weblinks and Investing-------------------
References:
Tweet 20Dec2020 on Gilt Funds Compare
Tweet 20Dec2020 Gilt Funds Compare (with other Twitter threads on taxation of gilt funds)
Tweet 19Mar2021 Corporte bond funds vs gilt funds
Abbreviations used:
SEBI - Securities and Exchange Board of India
Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.
Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.
CFA Charter credentials - CFA Member Profile
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He blogs at:
https://ramakrishnavadlamudi.blogspot.com/
Twitter @vrk100
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