Is it a good time to invest in Gilt Funds? They seem to have run up quite a bit in the last one year. I have a time horizon of three years or more in mind. I would like to take advantage of tax benefits available to debt funds over bank FDs. At the same time I do not want to take on higher risks. Is it advisable to invest lumpsum amounts in HDFC Gilt Fund - Long Term Plan, ICICI Prudential Long Term Gilt Fund, Reliance Gilt Securities Fund and SBI Magnum Gilt Fund - Long Term Plan? I have already invested small amounts in Franklin India MIP Growth, UTI MIS Advantage Growth and ICICI Prudential MIP – 25 Growth.

Vivek

No, this is not the ideal time for you to invest in long-term gilt funds for two reasons.

One, you say you are a risk-averse investor. Gilt funds, though they invest only in government bonds, do carry interest rate risks. Long-term gilt funds, in particular, are extremely sensitive to interest rate movements in the economy.

When interest rates in the economy fall, as they have since 2015, gilt funds deliver exceptional gains on the back of rising prices of government securities (G-Secs). But when interest rates rise, G-Sec prices decline, thus reducing the returns on gilt funds.

Gilt funds can even suffer losses for short time frames when interest rates are on a steady rise. Therefore your returns on long-term gilt funds depend a lot on whether you enter near the top or the bottom of a rate cycle. They are unsuitable for an investor who wants to avoid risks.

Two, in the case of gilt funds, past performance is certainly no indicator of future returns. The best time to buy long-term gilt funds is when interest rates in the economy are close to the top of a cycle. As you may know, the RBI’s benchmark repo rate, which was at 8 per cent in the beginning of 2015, has been steadily cut by 175 basis points in the past year or so and is now at 6.25 per cent.

The yield on the 10-year G-Sec, which is the benchmark for gilt fund returns, has tumbled from over 9 per cent to 6.7 per cent in the same period, a steep 230 basis points fall. It is this fall which has propped up gilt fund NAVs and resulted in double-digit returns from long-term gilt funds. As the downside for rates is limited from here, it is doubtful if gilt funds can repeat their past performance for the next one or two years.

Given your risk profile, Short Term Gilt Funds or Dynamic Bond Funds (which alter their maturity based on how they see rates moving) may be a better bet for your portfolio. SBI Magnum Gilt – Short Term Plan, ICICI Pru Gilt- Short Term Plan, HDFC Gilt – Short Term plan are options you can consider.

Birla Sun Life Dynamic Bond Fund and UTI Dynamic Bond are also options you can consider. Given the indexation benefits on taxation of debt funds after three years, you are right to maintain a three-year holding period.

I am looking to invest in debt funds (income accrual) for 7-10 years. Is it better to choose funds with average maturities of around 3-5 years, or should it be funds with longer maturities? What funds would you specifically recommend?

Karthik S

If we had close ended debt funds or Fixed Maturity Plans with a 10 -year maturity, they may have been ideal for your purposes.

You can just lock into them at current interest rates and redeem your units after a 7 or 10-year wait.

But as most debt funds in India are open ended and vary their maturity profile quite a bit with market conditions, you may have to choose from conventional debt funds.

You may be aware that long-term debt or gilt funds are more sensitive to interest rate changes, than short-term funds. Therefore, it makes sense to invest in funds with a long maturity when we are close to the top of an interest rate cycle.

Today, though, after a 175 basis point fall in the RBI’s repo rates in the last two years to 6.25 per cent, the time isn’t great to buy debt funds with a 7 to 10-year maturity.

It may be a better idea for you to invest in Dynamic Bond funds, which can lengthen their portfolio maturity when debt market conditions are more favourable. UTI Dynamic Bond, Birla Sun Life Dynamic Bond and ICICI Pru Long Term fund are good choices.

Send your queries to mf@thehindu.co.in

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