What are Gilt funds?

  • Gilt funds are debt mutual funds that invest in bonds and other fixed-income securities issued by RBI on behalf of the State or Central Government.
  • Since the investments are made in government securities; they carry negligible credit risk and are safe.
  • In the short-term, gilt funds are the riskiest among all other debt funds. Hence, investments made in Gilt funds are susceptible to the changes in interest rate. However, in a falling interest rate scenario, these funds can offer double-digit returns as well.

How do Gilt funds work?

What type of investors should have exposure?

  • Given the fact that Gilt funds invest in government securities of short, medium, and long-term horizons, they satisfy the security needs of most of the investors.
  • Despite belonging to the debt fund category, they do not allocate their assets in corporate bonds which is a risky venture. They invest in low-risk debt instruments that provide moderate returns along with capital preservation.
  • It is a safe investment haven for those investors who are risk-averse and want to get exposure in government securities.

Pointers to look at before Investing

  • Risk factor: Unlike corporate debt funds, Gilt funds are liquid investments that don’t entail credit risk as they are backed by government securities. However, funds are exposed to interest rate uncertainty.
  • Returns: Gilt funds can provide double-digit returns, however, since it is prone to interest rate risk; it can even end up in the negative regime. Nonetheless, one should only invest in gilt funds when inflation is near the peak and there is no likely chance of any interest rate increase.
  • Agency cost: Gilt funds also charge annual management fees (expense ratio). It is the percentage of the fund’s average AUM (Asset under Management). As per the SEBI stipulation, the upper limit of the expense ratio is 2.25%.
  • Investment horizon: The duration of investment can range from short-term (0-2 years), medium-term (3-6 years), and long-term (10-15 years). Having a duration of 3-7 years can be a path towards benefitting from no credit risk plus reasonable returns.
  • Financial objectives: If wealth accumulation over the medium-term is the goal then investing in gilt funds can be beneficial by riding on the interest rate volatility. Whereas, when overall capital markets see a downturn then Gilt funds are surely a haven to earn short-term returns.
  • Taxation Impact: Capital gains from this fund are taxable based on how long one stays invested in it. Investors will receive STCG (Short Term Capital Gains) and pay tax accordingly whereas LTCG (Long Term Capital Gains) tax is 20% on flat terms with some indexation benefits.

Perks of investing in Gilt funds

  • No credit risk: Capital protection is guaranteed as investments are made in government securities that are of high credit quality.
  • Moderate returns: Being creditworthy these funds generate moderate returns and thus, gives investors a good negotiation by balancing risk and return.
  • Access to G-securities: Requirement of large sum of money is not a hindrance. This allows retail investors to get exposure with minimum ticket size.

How did the COVID situation turn the game?

  • The coronavirus outbreak has imparted a severe blow to all the economies in general.
  • All the sectors of business are confronting the dearth of optimism. Retail, manufacturing, service, wholesale, education, and nearly all the sectors are facing a liquidity crunch, lay-offs, and financial distress.
  • People have turned more risk-averse than they were before the pandemic. Liquidity has become a major hindrance as investors are reluctant to invest their money. RBI has entered into a rate cut spree to revive the economy and instill a sense of optimism among the people.
  • Moreover, credit risk, defaults, redemption, and poor return in other debt funds has reduced investors’ risk appetite considerably. Investors are dubious to invest in corporate bonds, high-yield bonds, and bear the credit risk.

Historical Returns

  • More than 50% of the times, the one-year return has been above 9% whereas three-year and five-year returns tended to be in the 8-10% range.
  • Gilt funds locked a good return as compared to other debt funds, over a 3-year time frame due to negligible credit risk, RBI’s rate-cut measures and a drift towards safe havens.

The above graph shows a comparison between three-year returns generated by the gilt fund category and other debt funds of the respective mutual fund (MF) houses. Gilt funds have been generating good returns over a three-year period as compared to other debt funds because of the changes in investors’ behaviour and priority. They consider gilt funds to be the safest mode to lock their capital into and get them free from the thought of losing by investing in other debt funds which carry significant credit risk.


Since interest rates are falling, one-year investments might generate a double-digit return. However, high volatility of interest rates in the short-term and even medium-term is a real possibility. Investors seeking to look for the short-term benefit can lock in a good return and plan their exit within a year by playing on the interest rate fluctuations. However, investors who are less likely to make short-term returns and are risk-averse should stay invested for 5-7 years to reap the advantage of the falling interest rate plus capital protection.
It is hard to predict for how long will this situation prevail. But one thing that has come out is that investors are now very doubtful, and they are not willing to take any risk that might cost them a fortune. Investing their money in government securities are the safest option that they might think of. Now, let us see for how long will gilt funds be etching positive returns to the investors and what changes it might see once the turbulence subsides.

Contributor: Madhav Khemka
Research Desk | Leveraged Growth

I am a third-year B.Com (H) student at St. Xavier’s College, Kolkata and a CFA-L2 candidate. I have an ardour for Finance and an inquisitiveness to explore its universe. Writing, reading and playing badminton is my escape from the modus operandi. Dedication and commitment towards each and every endeavour has been my driving force.