Don’t Miss Investing in Gilt Funds Now for Better Returns

What will you do when making money on the equity markets is more dangerous than putting your head in a crocodile’s head? Well, if you decide that you are not going to risk your money and invest in banks, there comes the next shocker. The government is planning to cut down on interest rates. So there you have it; a volatile market, low interest rates and no option to invest.

However, you need not worry because there is always the option of investing in government bonds. These government securities (G-sec) are issued by the RBI. Therefore, there is no concern about the risk. The players in government securities are mostly big institutional investors.

For retail investors like us, who are not so familiar with G-secs and bond markets can invest with fund managers who invest the money in these G-secs. These funds are called Gilt Funds.

Earning Through Gilt Funds

Gilt funds are similar to mutual funds with the difference that it invests mainly in the low risk government securities (i.e Govt. Bonds). These bonds have interest or coupon rates that are fixed for the tenure of the bond, usually for 3 years to 20 years.

When the government reduces the market interest rates, the interest on the bonds does not fall, making it an interesting investment option for investors. They can transfer their funds from low interest bank deposits to high interest bonds.

When we speak of bonds and government securities, you must understand one thing; the bond can be also traded in bond market. That means the price of bond can vary depending on market conditions. Given that Gilt Funds invest in such bonds, the NAV of these funds are directly depending on bond prices.

That is, when bank interest rates are lower, there will be more demand to government bonds pushing their prices higher.  Conversely, the opposite happens if the market interest rate is higher than what is quoted by the bond. The bond prices fall in value and the yield is less than what the banks provide.

That implies investors can make profit by two methods. You can keep money locked in bonds for the entire tenure and get the returns on maturity. Otherwise, you could trade them in bond market. Gilt Funds make use of the second option.

Gilt Funds and Mutual Funds

These Gilt Funds invest only in G-secs giving it an advantage over risk and also provides good returns. Fund managers trade these G-secs on a secondary market to make profit.

When compared to mutual funds investing in other markets such as equities, Gilt funds are better. This is because of the security it provides. G-secs if held till maturity gives assured returns because it is government guaranteed. Even if it is traded in the bond market it is relatively safe because the volatility in bond market is small compared to equity markets.

However you must realize that when markets are steady and interest rates are climbing demand for these bonds diminish. This is because during boom period everyone is ready to take a moderate risk and invest in stocks.

Nonetheless the best time to invest in Gilt funds is when the markets are too volatile and inflation is rampant and the RBI is considering reducing interest rates. You must consult your manager to decide if you want to go for short term or long term investments. Invest long term in bonds if the interest rates are perceived to stay low for some time.

Is it Safe to Invest in Gilt Funds Now?

In India when the inflation is higher the RBI hikes the interest rates. However when it eases RBI lowers the rate to promote economy. This is when investing in bonds become profitable. The interest on the coupon doesn’t change. So your money can earn better than bank deposits.

Currently, the general talk is that the RBI is proposing a cut in interest rate, which has been high due to high inflation. The inflation rate is easing; therefore RBI will re-think its policy on high interest rates and may go soft on it.

Keep a close watch on how the interest rates are moving. If inflation shows a trend of easing a bit it is time to invest in gilt funds because low inflation will lead to lower interest rates. Lower interest rates means, higher demand for bonds, resulting in better returns from Gilt Funds.