Franklin fiasco: Gilt funds emerge as star in troubled debt MF pack

One-year return for fund category is 17 per cent

Amid the turmoil in the debt mutual fund space, the 10-year government bonds (gilt) segment has emerged as the ace in the pack. Sharper-than-expected rate cuts and liquidity measures by the RBI have helped the category deliver best returns in over a decade.
 

At present, the one-year return for the gilt fund category is 17 per cent — higher than the one-year return for the dozen-odd categories in the debt MF space. Also, the rolling one-year returns in the past six months have been as high as 20 per cent — the best since the 2008 crisis.
 

“This is not the first time the category has delivered eye-catching returns. In 2009, the returns for some of the schemes in this category were higher than 25 per cent after the US Fed injected liquidity in the system,” said Dwijendra Srivastava, CIO-fixed income, Sundaram Mutual Fund.

The gilt fund category mimics the returns of sovereign government bonds. As a result, the category has virtually no credit risks. However, the returns in the segment are impacted by interest rate movements and also tend to be volatile.
 

In the past one year, the yield on the 10-year government security has softened from 7.4 per cent to 6.15 per cent, translating into a price appreciation of 17 per cent. While the inherent coupon on such bonds tends to be low, the bulk of the gains accrues from price movements.

“Returns in any bond fund are a combination of accruals and mark-to-market capital gains or  losses. Assume the accrual in a gilt fund is 6.75 per cent. In April 2019, the 10-year yield was 7.4 per cent, and it is now 6.15 per cent. The yield downtick is 125 bps and assume the duration is seven years. Then the capital gain component is 125 basis points multiplied by the duration. This equals 8.75 per cent. Hence, the return is 6.75 per cent plus 8.75 per cent, and that is 15.5 per cent,” said Joydeep Sen, consultant, PhillipCapital.

While the gilt category has benefited from sharp slide in yields, the returns have also been volatile reflecting the wild swings in the 10-year government bonds over the past six months. “It is not right to say gilt fund is the safest. It is safe from the point of view of credit risk but not safe in terms of interest rate risks. That is the reason we have had this kind of volatility,” said Pankaj Pathak, a fixed-income fund manager at Quantum Asset.
 

Many believe the past one year returns are abnormal and one shouldn’t expect similar returns going ahead.

“Often investors invest based on past returns. That’s not the prudent way to invest. We have seen much of the rally play out. There is a lot of uncertainty as of now. If the government announces a fiscal stimulus that will be good for the economy but bad for the bond market,” said Pathak.