Interest rates and bond prices go hand in hand. Interest rates are inversely related, and rising interest rates will drive bond prices down. On the other hand, falling interest rates will make bond prices go up.
Investing in gilt funds during a low-interest-rate period will likely increase your returns. Since the government will likely not raise interest rates shortly, this is a safe bet. A falling interest rate cycle is a perfect time to buy gilt funds.
Gilt funds are a low-risk investment, but they largely depend on interest rates. This article will provide you with the basics of gilt funds and what you should expect from them. This article covers all gilt-funds related intricacies.
Did You Know?
If we talk about the "gilt-edged,” it might imply safety. However, an investigator with interest must check the ratings before purchasing. Gilt funds are basically pooled investment vehicles. Also, they hold British government bonds. Gilt funds low-yield investments and are conservative, which carries a low-risk factor.
Also Read: What Is the Difference Between Series A, B and C Funding?
What Is Gilt Fund?
Let’s start with knowing gilt fund meaning. Gilt funds fall under the category of Debt Funds and invest in Government securities. They are a great option for investors seeking stable returns. Because they are government-backed, they are a safe option, especially during falling markets.
They are low risk and offer high return rates. But the downside is that you will need to be patient to wait for interest rates to turn. There can be many reasons to invest in gilt funds. Gilt funds are sheltered from the volatility of the equity market.
Their average maturity period is inversely related to interest rates, and the fund manager can increase or decrease the portfolio's average maturity depending on the state of the market. But gilt funds are not for beginners. Only those with a deep understanding of the money and bond markets should invest in these funds.
How Do Gilt Funds Work?
Now that you know the gilt fund’s meaning let’s know how it works. The government's bond market is a key driver of the performance of gilt funds. The government issues these securities against money borrowed from banks and financial institutions.
Fund managers subscribe to these bonds and, upon maturity, return the securities to the government. They receive money and a coupon payment and interest on the money invested. A gilt fund is best suited for investors with a medium-term financial requirement.
This type of fund offers reasonable returns in a safe environment, but its volatility may put you at risk of short-term capital losses. In this way, it's an ideal place to park money during falling interest rates. However, there are several risks that you should be aware of before investing in a Gilt fund.
Rising interest rates reduce the value of gilt funds. If the interest rate increases, investors will shift their investments to newly-issued securities, which carry higher interest rates.
As a result, the demand for older bonds will fall, and the NAV of gilt funds will decrease. In addition, the sensitivity of bond prices to interest rate movements is measured by modified duration. The modified duration of a bond is 5% for every one per cent increase in interest rates.
Benefits of Investing in Gilt Funds
- Low risk: Because Gilt Funds invest primarily in government securities, they are backed with sovereign guarantees. Because the government issues the underlying securities of these funds, they carry very low credit risk. This makes Gilt Funds a great investment option for risk-averse investors.
- Investment Horizon: Gilt Funds offer medium- to long-term investment options. The fund manager invests in Gilt Funds with maturities ranging from 3 to 5 years. To earn the expected returns, you must ensure that you remain invested during this period.
- Returns: The interest rates you receive when you invest in Gilts will determine the number of your gains. Interest rates can change from time to time, and you may not get regular returns. You can still earn returns up to 12% in a period of falling interest rates. However, if the interest rate rises sharply, the fund's Net Asset Value (NAV) may drop dramatically. The Gilt Funds returns rate in a bear market can be higher than equities.
Who Should Invest in Gilt Funds?
Gilt funds invest only in high-credit quality government securities and offer a relatively moderate risk-free return over the medium to long term. However, they come with their own risks, especially since their returns are affected by an increasing interest rate regime.
Government securities are safe but aren't always as liquid as other investments. Government securities are out of the reach of the average investor. Therefore, gilt funds allow individual investors to indirectly invest in government securities through a fund.
Gilt funds can sound like a magic investment scheme because they have no credit risk and high returns. However, gilt funds aren't appropriate for beginners. They should only be owned by those who can't wait for the market to rise. And they're only suitable for investors with a short to medium-term time horizon.
How to Invest in Gilt Funds?
ClearTax makes it easy and paperless to invest in gilt funds. Follow these simple steps to get started on your investment journey.
- Register at your chosen gilt tax provider's website.
- Please enter your details, such as the amount and duration of the investment.
- Your e-KYC completed in under 5 minutes
- Choose your favourite gilt fund from the hand-picked mutual money funds to invest in.
Also Read: Masala Bonds and What Makes Them So Appealing
Things to Consider as an Investor to Opt for the Best Gilt Funds
There are numerous considerations when choosing an investment, but each investor has its own set of criteria for investing. Some investors base their decisions on facts and data, while a management's personality more influences others.
Risk-taking isn't for everyone, and some investors may prefer to play it safe while their outstanding investments grow. It all depends on your personal criteria. Consider these things when choosing an investment:
Risk Factor
The risk factor is a common source of volatility in the equity market. It can have high correlations with other securities in the same class when it affects particular security. Combined, these can lead to joint losses during severe bear markets.
Many macroeconomic variables are considered risk factors. Statistical analysis is used to extract them from asset returns. While no single factor can guarantee a profit, many investors spread the risk by investing in various assets. A well-diversified portfolio will minimise your overall risk and spread it across several asset classes. This is known as factor investing. It has several advantages.
Diversifying your investments can reduce the risk of over-investment and provide a better return potential. Although this strategy is not for everyone, it is one of the most popular forms of investing in the stock market.
Cost
Many investors do not understand the cost of investing and may not understand the costs involved. Although costs are not always obvious, understanding them is necessary if you want to have a successful investment plan.
For example, the cost of hiring a full-time financial advisor or purchasing higher expense ratio assets may not be worth it. A fund's fees are one important part of the total cost of investing. The cost of a fund's annual expenses is one of the most important factors in determining future investment performance.
Returns
Investing in index funds can improve your returns. Studies have shown that good advice can boost returns by as much as 3.75% per annum. This does not include the tax benefits or the financial planning benefits that can also boost returns. Therefore, investing with good advice is always a good idea.
Financial Goals
You should focus your investing and saving efforts on achieving your financial goals. Aiming to make ₹10,000 a month or more is not challenging enough. You should create a plan and feel fulfilled when you achieve it.
You can divide your goals into short-term, medium-term and long-term, depending on your goals. While you may not have the same investment strategy for all of your financial goals, setting specific, short-term financial goals and investing accordingly is important.
Your goal should be relevant to your life and lifestyle. For example, if you earn ₹5,00,000 a year, it is not realistic to set a goal to save ₹4,00,000 by the end of your first year.
To achieve this goal, you'd have to make major lifestyle changes or find a new source of income. Setting impractical financial goals will only lead to frustration if you miss them. Aiming too high will make you quit the goal altogether.
Investment Horizon
As an investor, you must decide how long you are willing to stay invested. The time you decide to remain invested will depend on your age, investment strategies and financial goals.
For example, if you want to retire at the age of sixty-five, your time horizon may be longer than if you're trying to fund a down payment for a home. On the other hand, your time horizon will be much shorter if you're investing to fund your child's college education.
Conclusion
Gilt funds are not appropriate for all investors. They are highly sensitive to interest rate movements, and their duration means that investors should regularly monitor their NAV (net asset value) to avoid losses.
Also, gilt funds tend to have an expense ratio based on the AUM of the fund or average assets under management. This expense ratio is a measure of the fund's overall risk. The longer the fund is held, the higher the risk. Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.
