Should You Consider Investing in Gilt Funds at This Juncture?
Yields Become More Attractive
The recent movement in government securities schemes of mutual fund houses has caught the attention of investors. According to the Association of Mutual Funds in India (AMFI), gilt funds witnessed net inflows of Rs 396 crore in June 2023, a significant increase compared to the outflow of Rs 127 crore in May. This surge in investment reflects investors' renewed interest in gilt funds, leading us to question whether it makes sense to invest in these funds at this juncture.
The attractiveness of gilt funds is closely tied to the yields they offer. In February 2023, the 10-year benchmark bond yield reached an intermediate high of 7.42 percent but gradually decreased afterward. Many investors opted to invest in long-term gilts through mutual funds to take advantage of indexation benefits. However, on July 10, the yield on the benchmark 10-year government security rose to 7.16 percent, bouncing back after briefly trading below the psychologically important 7 percent mark. This recent fluctuation in yields prompts us to wonder if they will move down again.
Factors Influencing Yields
The movement of 10-year benchmark bond yields depends on various factors, with inflation expectations being a crucial element. Currently, most market participants and the Reserve Bank of India (RBI) do not anticipate a decrease in inflation. As a result, the RBI has maintained policy interest rates, waiting for inflation to cool off. The expected interest rate cuts are scheduled for next year, and they are likely to affect long-term bond yields as well.
Marzban Irani, Chief Investment Officer of Debt at LIC Mutual Fund, states that given the global uncertainty, strong domestic economic growth, and stable inflation around 4.5 percent, there is no rush for the RBI to cut rates in the near term. He expects rate cuts in the next financial year, noting that short-term bond yields may decrease before long-term bond yields follow suit. Irani also predicts a slight increase in inflation before it starts declining.
Understanding Gilt Fund Investments
Joydeep Sen, a Corporate Trainer specializing in debt, highlights the relationship between the repo rate and the 10-year benchmark. On average, the difference between these two rates is approximately one percentage point. As of now, it stands at around 65 basis points, indicating that investing in gilt funds solely for trading gains may not be advisable.
Rising Investor Interest
Gilt funds experienced a substantial increase in net inflows in March 2023, with investors pouring in Rs 4,430 crore. The allure of indexation benefits and the concessional tax rate of 20 percent on long-term capital gains for debt fund units held for three years ended on March 31, 2023. Many investors took advantage of this opportunity, particularly due to falling long-term bond yields, which tend to drive up the prices of long-term government securities.
As per Value Research, gilt funds, as a category, provided a return of 6.89 percent in the last year ending on July 10, 2023.
Making Informed Decisions
Despite the inflows observed in gilt funds, experts advise against expecting quick capital gains from these funds. Irani suggests that a range of 7.15 to 7.25 percent on the 10-year benchmark bond yield is an opportune entry point for well-informed investors with a time horizon of 2-3 years.
Gilt funds primarily invest in government bonds, with the fund manager deciding on the duration based on their view of interest rates. On average, the gilt funds' average time to maturity and modified duration stand at 5.68 years and 3.97 years, respectively, as of June 30, 2023. However, it's important not to solely rely on averages, as some schemes have an average time to maturity as high as 9 years. Schemes with longer duration are more susceptible to changes in interest rates. To navigate the volatility of long-term bonds and associated schemes, it is advisable to adopt a long-term investment perspective.
Sen points out that gilt funds, being credit risk-free products, can be considered by those with a long-term investment horizon.
However, Vikram Dalal, Founder & Managing Director of Synergee Capital Services, holds a different opinion. He sees more value in short-term papers maturing within one year compared to their longer-term counterparts. According to Dalal, investors would be better off investing in such papers or money market funds. They may consider transitioning to long-term funds or gilt funds in six months if they find the yields attractive.
In conclusion, investing in gilt funds requires careful consideration and an understanding of the current market dynamics. It is essential to assess the yields, inflation expectations, and the duration of the funds before making any investment decisions. By staying informed and adopting a long-term perspective, investors can position themselves for potential growth and returns in gilt funds.