Gilt funds regain glitter with Rs 396-crore inflow from investors

Mutual fund investors bought into the units of gilt funds in June 2023 after a short break in May.

Mutual fund investors bought into the units of gilt funds in June 2023 after a short break in May. Compared with the outflow of Rs 127 crore in May 2023, gilt funds saw net inflows of Rs 396 crore in June 2023. As investors are seen coming back to gilt funds, does it make sense to invest in gilt funds at this juncture?

Yields become more attractive

The 10-year benchmark bond yield made an intermediate high of 7.42 percent on February 28, 2023, and then started moving down as many investors preferred to invest in long-term gilts through mutual funds to avail indexation benefit. The yield on the benchmark 10-year government security bounced to 7.16 percent on July 10 after trading below the psychologically important mark of 7 percent for a brief period last month. After the temporary propped up demand for long-term gilts cooled off, the yields bounced back.

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Will yields move down again?

Movement in 10-year benchmark bond yields depends on various factors including inflation expectations. For the time being, most market participants and the Reserve Bank of India do not expect inflation to go down. The RBI has been holding the policy interest rates as inflation is yet to cool off. The interest rate cuts are expected next year, which will have a rub-off sentimental effect on long-term bond yields as well.

Marzban Irani, CIO- Debt, LIC Mutual Fund, says, “In the near term given the global uncertainty, strong domestic economic growth, and relatively stable inflation at around 4.5 percent, there is no reason for the Reserve Bank of India to cut rates in a hurry. Expect rate cuts in the next financial year. Short-term bond yields may come down before the long-term bond yields.” He expects inflation to inch up before coming down.

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Joydeep Sen, Corporate Trainer-Debt, points out that the difference between the repo rate and the 10-year benchmark has been around one percentage point on average. “As of now it quotes around 65 basis points, which means do not enter gilt funds for trading gains,” he says.

Rising investors interest

Gilt funds saw net inflows of Rs 4,430 crore in March 2023. The indexation benefit and concessional rate of tax at 20 percent on long-term capital gains on debt fund units sold after holding for three years came to an end on March 31, 2023. Many investors wanted to make the most of this opportunity. Falling long-term bond yields also attracted a few investors to these funds. Many gilt funds invest in long-term government securities, the prices of which tend to go up in a falling yields environment.

Gilt funds as a category have given 6.89 percent returns in the last one year ended July 10, 2023, as per Value Research.

What should you do?

Though gilt funds are getting inflows, experts rule out quick money from these funds through capital gains. Irani says, “7.15 to 7.25 percent range on 10-year benchmark bond yield is a good entry point in long-term gilt funds for informed investors with 2-3 years of time horizon.”

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Gilt funds invest in government bonds and the fund manager decides on duration depending on his view on interest rates. On average the gilt funds’ average time to maturity and modified duration stands at 5.68 years and 3.97 years respectively, as on June 30, 2023. Do not go by averages, as some schemes have an average time to maturity pegged at as high as 9 years. Schemes with higher duration will be more susceptible to changes in interest rates. The best way to overcome volatility in long-term bonds and schemes investing in them is to invest with a long-term view.

Sen says, “Gilt funds being credit risk-free products can be looked at by those who have a long-term investment horizon.”

Vikram Dalal, Founder & Managing Director, Synergee Capital Services, however, has a different take. He finds a lot more value in short-term papers maturing in one year than their longer-term counterparts. “Investors are better off investing in such papers or money market funds. They may decide to move to long-term funds or gilt funds six months from now if they find yields attractive,” he adds.

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If you do not understand the complexity of interest rate cycles or want to avoid high volatility arising out of quick moves in interest rates, then you should ideally be investing in short-term debt funds.