Gilt funds, which invest exclusively in government securities, have gained traction among Indian investors seeking. These mutual funds mainly invest money (over 80% of holdings) in government bonds issued by the Reserve Bank of India for the central government. These bonds can have different durations, ranging from a few years to as long as 30 years. In this article, we will cover whether these funds are a safe haven or a hype.
Are Gilt Funds Safe Havens?
Let’s look at howgilt funds can be a safe haven:
Zero Credit Risk
Gilt funds invest in government securities, which the central government backs. This means there is no credit risk involved, unlike corporate bonds, where defaults can happen. Investors are assured that the principal and interest will be paid, regardless of the economic situation.
Falling Interest Rates
Gilt funds tend to do well when interest rates decline. This is because, in the bond market, the value of existing government bonds with higher interest rates increases as new rates go down.
Since gilt funds hold long-duration bonds, they see a significant capital appreciation during such phases. This makes them a strategic tool for investors who can time rate cycles. Unlike FDs or short-term debt funds, gilt funds offer dual benefits: safety of capital and potential for returns when interest rates fall.
Transparent Holdings
Unlike hybrid or thematic funds, gilt funds are very transparent in their holdings. Since they only invest in government securities, investors can easily analyse the portfolio quality and interest rate sensitivity.
There is no ambiguity around what the fund manager is doing. Moreover, the portfolio does not contain any sectoral or equity risk, which is often a complication in other mutual fund categories.
Inflation-adjusted Returns
While not direct inflation beaters, gilt funds, such as SBI Magnum Gilt Fund, can offer inflation-adjusted returns in specific macro environments. During disinflation or controlled inflation periods, the capital appreciation from a bond price rise can outpace inflation.
More importantly, when real interest rates turn positive (interest rates minus inflation), gilt funds can preserve and grow wealth better than bank deposits.
Why Gilt Funds May Just Be Market Hype?
Here are some downsides of gilt funds:
Lack of Diversification
Gilt funds invest only in government securities, so they lack diversification in terms of issuer type and credit risk. Unlike corporate or dynamic bond funds, they can’t switch to higher-yielding instruments when government bond returns decline. This limited flexibility hurts performance, especially when inflation outpaces yields.
Poor Timing
The performance of gilt funds heavily depends on timing the interest rate cycle, something even professional fund managers struggle with. If an investor enters when rates are low and rising cycles begin, the fund may underperform for years. Unfortunately, many investors enter such funds when past returns are high, only to see the returns crash later.
Highly Interest Sensitive
While they benefit from falling rates, gilt funds suffer heavily when interest rates rise. Because they hold long-duration government securities, even a small rate hike can significantly lower NAV. If the investor exits during a rising interest rate cycle, losses can be substantial, and capital erosion is real.
Conclusion
Gilt funds can offer stability and decent returns during falling interest rate cycles, thanks to their zero credit risk and government backing. However, they are not foolproof. Their high sensitivity to interest rate changes and lack of diversification can hurt returns if market conditions shift. So, are gilt funds safe havens or hype? The answer lies in timing and understanding.
