A gilt fund is a debt mutual fund which primarily invests in government securities. Due to the fact that the securities in this fund are government-backed, the risk of default on both interest and principal is minimal. However, gilt funds are always subject to market risks, especially interest rate changes. By investing in such funds through a mutual fund application, investors can have access to government-backed instruments without the need to buy them individually from the bond market. This article explains how gilt funds works, its types, features, advantages, and the possible risks associated with gilt funds.
How Gilt Funds Work
A gilt fund needs to invest a minimum of 80% of the corpus in government securities, according to SEBI guidelines. Short-term treasury bills or long-term government bonds are used by fund managers, depending on the fund’s strategy.
Funds of various investors are combined and allocated to such securities. The value of the investment can change according to the varying interest rates. Prices of government securities may rise when interest rates fall, and this could lead to a rise in the fund’s value. The opposite could happen when interest rates rise.
Types of Gilt Funds
Gilt funds may be classified on the basis of the maturity of the securities they hold in the following ways:
- Short-term gilt funds essentially invest in short-term government bonds. These funds typically have a reduced sensitivity to interest rate fluctuation, which may consequently lower volatility.
- Long-duration gilt funds invest in government securities of long tenure. Their value may increase when interest rates decline but may also decrease when rates increase.
- Dynamic gilt funds change the portfolio maturity dynamically in response to the changing interest rates.
Features of Gilt Funds
These funds have a few characteristics that differentiate them from other debt funds. Some of them are as follows.
- Government-backed Investments: The capital is invested in securities issued by the government, thus effectively reducing credit risk. This means there is a minimal chance that the issuer will default on repayment obligations.
- Interest Rate Sensitivity: Gilt fund performance is sensitive to interest rate fluctuations. A decline in interest rates can lead to an increase in the market value of the underlying bonds, hence being favourable for investors. A rise in interest rates may have the reverse effect.
- Market-linked Performance: Even though they invested in government securities, there is no assured return. The value of your investment fluctuates daily based on current market conditions.
- Portfolio Transparency: As gilt funds invest in securities only issued by the government, their portfolio holdings are simple enough for investors to understand.
Advantages of Investing in Gilt Funds
While gilt funds do have some risk associated with them, they also provide several benefits. Some of them are as follows.
- Minimal Credit Risk: Since the securities are backed by the government, there is minimal chance of default. Thus, this may make gilt funds a suitable choice compared to corporate bond funds, which carry credit risk.
- Portfolio Diversification: Gilt funds may introduce stability to your debt portfolio and reduce the potential risk associated with your portfolio.
- Technology-based Accessibility: Investment and redemption in gilt funds can be done easily through a mutual fund app, eliminating the need to directly invest through the bond market.
- Potential for Capital Appreciation: When interest rates fall, the prices on government bonds usually rise. Gilt fund investors can therefore benefit from these price movements, especially in funds with longer maturities.
- Eligible for Investment in Long-Term Debt: For investors with a medium to long-term investment horizon, gilt funds can be a suitable component for your portfolio.
Risks Associated with Gilt Funds
Though gilt funds have minimal credit risk, they are not risk-free. Some of the potential risks are as follows.
- Interest Rate Risk: It is the significant risk associated with gilt funds. Interest rate and bond price are inversely proportional. In case interest rates go up, bond prices go down, which in turn will decrease the worth of your investment.
- Volatility in the Market: Gilt funds can experience volatility due to a change in economic policy, anticipated inflation, or international incidents that affect interest rates.
- Liquidity Risk: This is rare, but there might be short periods when it is difficult to sell large amounts of government securities at favourable terms, thus impacting fund performance.
- Concentration Risk in Debt Securities: As these funds are concentrated in government securities, investors may miss out on instruments such as high-yield corporate bonds.
Conclusion
A gilt fund is an efficient way of investing in government bonds without being directly exposed to the bond market. It offers a minimal credit risk and potential for capital appreciation that reduces with changes in interest rates. With a clear knowledge of the risks involved, a review of your investment horizon, and monitoring economic conditions, you can determine whether gilt funds are a suitable option for your financial plan. A mutual fund platform like Axis MF helps you invest and track your progress, making it easier to add gilt funds to your portfolio.
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