The year of 2020 may have been unkind to many mutual funds and their investors, but there have been some that have withered the storm quite well. Take the case of some categories of debt funds. An unlikely winner over the past year or so, despite the massive credit crisis that affected many debt funds, is a special type of government securities (g-secs) funds. These are g-sec funds that come with a constant maturity profile; typically 10 years. Three of these schemes are in the top-10 in terms of returns among all debt funds over the one-year period.
How do these schemes work?
These schemes invest a minimum of 80 per cent of their portfolio in government securities, such that the underlying duration of the scheme portfolio is equal to 10 years. Known more popularly as the Macaulay duration, this is the weighted average maturity of bonds in a portfolio, keeping all cash flows the underlying securities earn.
By investing in these schemes, investors get exposure to long-term government bonds. There are five such schemes of mutual fund houses: DSP, ICICI Pru, SBI and IDFC. According to Value Research, in the past one year, these schemes have given 13.76 per cent returns on an average.
Do they work like regular gilt funds?
These are not your traditional, plain-vanilla gilt funds. A 10-year constant maturity gilt fund aims to invest its entire corpus in either the 10-year government security, or a mix of sovereign bonds, in such a way that the fund’s Macaulay duration remains 10 years.
There is no restriction as such on the fund manager to maintain the duration of the portfolio. When interest rates fall, such gilt funds invest in longer maturity securities because these benefit the most in a falling interest rate scenario. When rates rise, the fund manager may choose to invest in government securities maturing in the short term to cushion the volatility.
These schemes also differ from long-duration funds, as such schemes invest in bonds in such a manner that the duration is above seven years. There is no restriction on the credit rating or the issuer of the bond.
However, in the case of gilt funds with a 10-year constant duration, both the restrictions – the mandate to invest in government securities and maintain a portfolio duration at 10 years – apply.
Are g-secs risk-free? Yes, but partly. Government securities are sovereign, but they are also volatile.
If the interest rates go down, as they are now, the prices of long-term bonds increase and vice-versa.
Should you invest?
These funds are not actively managed. While they do well in a falling interest rate regime, returns can be hurt when rates rise.
“In case interest rates move up fast, bond prices fall and returns may come under pressure,” says Joydeep Sen, founder of wiseinvestor.in.
To make the most out of a gilt fund, you need to time your entry and exit a bit carefully. You may even face losses for a short period of time.
Ideally, your holding period and the maturity profile of the debt fund need to match. For 3-4-year investments, corporate bond and banking & PSU debt funds may be suitable. For 1-2-year timelines, short duration funds may fit the bill.
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