Gilt funds: Returns and inflows to take a hit

Fund managers advise investors to reduce holding durations

After equities, gold exchange-traded-funds; and now, it’s the turn of gilt funds to take a severe hit on returns and inflows after the Reserve Bank of India’s (RBI) raised the repo rate.

Gilt funds, which primarily invest in government securities, are at stake as expectations of interest rate cuts have gone for a toss upon RBI’s surprise move to increase the repo rate by 25 basis points (bps).

According to fund industry’s fixed income managers, returns from gilt funds (which ranged between nine per cent and 12 per cent till recently) will be impacted. They add that investors may even see negative returns, if they hold on long durations. Moreover, even for short durations, say one-to-two years, the returns may not be more than eight per cent.

Alok Singh, chief investment officer (CIO) - fixed income at BOI AXA Mutual Fund, says: “Against expectations, rate cuts have to wait now. Repo rate may be further increased to 7.75-8 per cent, which will not let interest rates climb down soon. RBI’s focus has now shifted to inflation. Investors should start reducing durations as risk-reward ratio still remains relatively high. However, one may not take risk by continuing with long durations.”

Gilt funds have been doing good for most part of the past year in terms of inflows. There were months when the industry could witness a continuous net inflows of Rs 1,000 crore. All these inflows came at a time when the market participants were expecting interest rates reversal. However, now the situation seems to have turned completely. As of July, 9.01 per cent of mutual fund industry’s asset under management were pumped in government securities. This is one of the highest exposures in G-secs in the last few years.

Sujoy Das, head of fixed income at Religare Invesco Mutual Fund, agrees. “Fear of inflation going up is coming back. With the latest repo rate hike, I do not foresee 10 year yield to come to 8 per cent. It will remain between 8.5 and 9 per cent. Investors in gilt funds need to be cautious depending on their durations. It is advisable to have durations of not more than two years.”

Already, there is sharp difference in returns from gilt short-term funds and gilts medium-to-long-term funds from a year perspective. As on 20 September, category average return from short-term gilt funds stood at 8.97 per cent while those of medium-to-long-term were at 5.86 per cent.

Fund managers added that interest rates may be further hardened. And that will not serve good for gilt funds. According to them, inflows in gilt category will decline going forward.

Arvind Chari, senior fund manager at Quantum Mutual Fund, says, “There could be negative returns if one has long durations. I believe that increment inflows will be limited and investors will redeem.”

Sales of gilt funds have remained robust for the past several months. However, with no visibility of rate cuts at least for next six months, it is widely being anticipated that investors would rush in to withdraw money from gilts.

As on August 31, assets under management in gilt funds stood at Rs 8,890 crore or 1 per cent of the industry's overall assets.