Gilt Funds: Features, Returns, and Benefits

Mutual funds are a popular investment option for many people, and they are not a new concept. 

 

Debt funds are mutual funds that invest a significant amount of the money of their investors in fixed-income assets such as government securities, debentures, corporate bonds, and other money-market instruments. Debt mutual funds are significantly less risky than other mutual funds.

 

In this article, we will learn about Gilt funds, which are one such mutual debt fund.

 

What is a Gilt Fund?

 

Gilt funds are debt funds that invest primarily in central and state government assets. 

 

When the government needs money to support a certain project, these securities are issued. The interest or coupon rate, as well as the maturity time, varies between these instruments. Gilt funds are a fantastic alternative for risk-averse investors because government assets are recognized to be a secure investment route.

 

Gilt Funds are a sort of British investment fund that invests in gilt securities, and the concept originated in the United Kingdom. Gilts are their nations' equivalents of US Treasury securities, and they originated in the United Kingdom, where gilt funds are still widely used today.

 

This information has been sourced from Investopedia, and to read more about the U.K. Government Gilts, click here.

 

This article will be about Gilt Funds in general, irrespective of any particular country.

 

Also Read | 4 Types of Bonds

 

Working of Gilt Funds

 

There are two types of Gilt Funds:

 

• The first is a fund that invests largely in government securities of various maturities.

 

• The second kind has a continuous maturity of ten years, but the investors must invest at least 80% of their assets in ten-year government securities.

 

Because these schemes invest in government assets, investors should be aware that there is no danger of default. 

 

They do, however, carry a high-interest rate risk. Interest rates in the money market and the economy are set by government securities.
 

The most widely traded 10-year government bond serves as the baseline. The bond market's tone is determined by its yield movement. Traders, for example, search for trading opportunities based on interest rate differentials between government bonds and corporate bonds or the 10-year bond and other government bonds, as written by INDmoney.

 

The gilt fund investors get their returns by investing in debt instruments, which create interest income. The performance of any gilt fund is determined by the direction of interest rates. As a result, gilt funds are highly recommended during the current rate-cutting period.

 

Most mutual fund managers do not advise their regular clients to invest in gilt funds. Only investors with a strong understanding of the money market or bond market, they feel, should invest in these schemes. 

 

Because these schemes are particularly sensitive to interest rate swings, it is critical to time your entry and exit. They perform well while interest rates are down, but when rates begin to rise, they suffer and begin to give negative returns.

 

Also Read | 10 Best Mutual Funds to Invest

 

Duration of a Gilt fund

 

When it comes to durations, Gilt funds have no restrictions on how long they can hold a position. Gilt funds have a modified duration ranging from 2.6 to 7.7 years as of October 2021. 

 

Modified Duration is a measure of bond prices' sensitivity to interest rate movements.

 

As previously stated, there are two types of gilt funds, both of which invest at least 80% of their portfolio in G-Securities. 

 

One type of gilt fund invests in G-Secs of various maturities. 

 

Second, gilt funds that invest with a constant maturity of 10 years, resulting in a portfolio with a Macaulay duration of 10 years.

 

The Macaulay duration of a fixed income instrument is the weighted average number of years an investor must keep it until the present value of the cash flows equals the amount paid for the asset.

 

The Morning star has answered some questions about Gilt funds, you can check them out here.

 

Features of Gilt Funds

 

Following are some of the features of Gilt funds that one must consider before investing in any gilt fund:

 

1. Volatile interest rates:

 

Gilt funds, unlike corporate bond funds, are the most flexible assets since they do not carry credit risk. It is a type of liquid fund. The reason for this is that the government would always do its utmost to meet its duties. 

 

But, gilt funds are largely exposed to interest rate risk. During periods of rising interest rates, the fund's net asset value plummets dramatically.

 

2. Unpredictable return rate:

 

Gilt funds have the potential to generate returns of up to 12% (according to clear tax). Returns on gilt funds, on the other hand, are not guaranteed and are extremely changeable in response to fluctuations in general interest rates. 

 

As a result, when interest rates are decreasing, it makes sense to invest in Gilt funds. Furthermore, even if the economy as a whole is in a depression, gilt funds are likely to outperform even equity funds.

 

3. Expenses of the Gilt Fund:

 

Gilt funds have an annual fee known as the expense ratio, which covers the fund manager's fee as well as additional costs. This is expressed as a percentage of the average Asset Under Management (AUM) of the fund.

 

[The entire market value of the investments that a person or corporation manages on behalf of customers is known as assets under management (AUM). The criteria and formulas for assets under management differ from firm to company.]

 

The running cost of a fund is mostly determined by the investment strategy and portfolio management of the fund manager. For example, in dynamic bond funds, the fund manager can purchase and sell securities in response to interest rate fluctuations.

 

4. Taxation of the Gilt fund:

 

The gilt fund's capital gains are taxed. The tax rate is determined by the length of time the investor has invested in the fund. 

 

Short-term capital gains (STCG) are those gained in less than three years, whereas long-term capital gains (LTCG) are those made in more than three years. 

 

Investors will receive the STCG from gilt funds and will be responsible for paying the tax. The LTCG tax, on the other hand, is a flat 20% with indexation advantages.

 

Also Read | 13 Types of Taxes

 

Returns of Gilt Fund

 

Interest earned or yield on instruments owned, as well as any capital gain or loss, are included in the returns from debt funds, including gilt funds.

 

Bond price changes, which are inversely connected to interest rates, cause capital appreciation or loss. As a result, if interest rates rise, bond prices decrease, and vice versa, with longer-term bonds being more susceptible to interest rate swings than shorter-term bonds.

 

Gilt funds tend to hold medium to longer-term papers, therefore capital appreciation or loss accounts for a bigger share of their return. Returns on gilt funds aren't guaranteed and fluctuate depending on the current interest rate cycle and the fund manager's abilities.

 

Advantages of Gilt Funds

 

Now that we have learned the things we have to keep in mind before investing in any Gilt fund, it is also important to know about the advantages that we can get from gilt funds. 

 

1. One of the best things about gilt funds is that it has zero credit risk, unlike mutual funds that invest in corporate bonds. As it is discussed before, this is because the Government does everything to fulfill its responsibilities. 

 

2. While no mutual fund can provide guaranteed capital protection, gilt funds are among the few that do. Investments are made in government-backed securities, therefore there is very little risk of a substantial financial loss.

 

3. Even if the investor is investing for a short to medium period, gilt funds offer reasonable returns when compared to many other investment possibilities. This is a fantastic alternative for risk-averse investors because of the low risk.

 

4. The majority of government securities are out of reach for individual buyers. Institutional investors, such as hedge funds, are permitted to subscribe to such securities. As a result, investing in gilt funds allows investors to indirectly invest in government securities.

 

 

Final Words:

 

Gilt funds sound like a magical investment scheme, with no credit risk and high return rates. But everything is not as simple as it looks. Only invest in these funds if you have the patience to wait for the interest rate cycle to flip around; in other words, investors will only gain from gilt funds if they hold them for a long period. This will assist investors in taking advantage of low-interest rates. 

 

To summarise, if you understand what a gilt fund is in a mutual fund, deciding whether or not they are the best decision for you should be simple. 

 

Gilt funds with a short to medium-term investment horizon are preferred by risk-averse investors. 

 

If you already have a mutual fund portfolio, gilt funds are a wonderful way to add additional variety and stability to it, especially if it is more geared toward equity.

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