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Monday, February 25, 2013

Gilt Funds are good investments for the long term

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ASSET management companies (AMCs) in the domestic mutual fund industry has shown a new keenness to launch new, or promote existing, gilt funds over the past one year. Gilt funds are debt funds that invest predominantly in government securities (GSecs). G-Secs are typically long-dated debt paper issued by the central government with tenures ranging from 10 years to 30 years.

 

Calendar year 2012 saw five new gilt funds being launched by five AMCs, more than four new gilt fund launches in 2011 and three each in 2010 and 2009. The current calendar year 2013 has seen one gilt fund launch, which took off as recently as this week itself on Thursday, February 14.


Why are they promoting gilt funds now? Given the plateauing out of interest rates last year and a small cut in repo rate this year, AMCs have been eyeing opportunity to promote gilt funds, the justification being long-term debt securities, such as G-Secs, will see the most rise in their trade prices when interest rates fall and result in higher net asset value (
NAV) for investors.


Why should you not fall for it? Debt fund investors should not fall for this line of reasoning because gilt funds are supposed to be for those with a long-term horizon. Gilt funds typically have their portfolios' average maturity between six and 10 years. Therefore, any fixed income investment in long-tenured in struments should not be based on speculative gains arising out of forecasts of interest rate movements.

Moreover, over five years, interest rates tend to complete at least one cycle of upturn and downturn and staying invested in a gilt fund will see NAVs gain or lose accordingly. The main issue for a gilt investor should be the returns that long-term GSecs are offering. For debt fund investors wanting to partake of a debt fund manager's ability to profit from interest rate fluctuations, the better options are the short-term debt funds or dynamic bond funds.

Gilt funds' poor long-term performance: The long-term performance of gilt funds does not lend comfort to a debt fund investor who does not want to play the short term speculation game of interest rate movements.

An FC Research Bureau analysis of the five-, seven and nine-year compound annual growth rate (CAGR) of return of different debt fund categories brings this out. There are 25 gilt funds launched over nine years ago. As of February 12, the average of their nine-year CAGR of return was 5.91 per cent, lower than the nine-year average CAGR of returns of 7.41 per cent and 6.42 per cent given by 18 short-term debt funds and 34 income funds, respectively.

In the five and seven year periods, the average CAGR of return of gilt funds were 7.23 per cent and 7.07 per cent, respectively. These, too, were lower than corresponding returns of 8.33 per cent and 8.15 per cent of short-term debt funds and 7.46 per cent and 7.34 per cent of income funds.

Many income funds and short-term debt funds too have varying exposure to GSecs. It is better for a debt fund investor to be in a all comprehensive debt fund rather than a stand-alone gilt fund.

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