Despite high returns, avoid gilt funds if you are a small investor

Entry and exit need to be timed, which is difficult for small investors

Gilt and long-duration funds are giving double-digit returns as there are expectations that the Reserve Bank of India (RBI) will go for a rate cut in June. Gilts and longer-duration papers are highly sensitive to interest rate movements and the returns shoot up as rates fall.

The one-year average returns from gilt funds are at 10.18 per cent. In the same duration, the returns from the other gilt category — 10-year constant duration — are at 11.85 per cent. There is also the newly introduced long-duration debt category, which has given 11.53 per cent returns in the past year. The three categories have also given higher returns than other funds in the short term — one month and three months. According to Soumya Kanti Ghosh, group chief economic adviser at SBI, the RBI can go for a rate cut of 35-50 basis points. “Gilts may give double-digit returns in the near future, but we ask retail investors to stay away from the category as its highly volatile,” says Vidya Bala, head, Mutual Funds Research, FundsIndia.

The returns from gilt funds could remain in double digits or higher than other debt fund categories if the rates fall. But if they don’t, the returns could even take a beating. “The entry and exit have to be tactical, which retail investors cannot do on their own. Unless an investor has a financial planner, the category is best avoided,” says Malhar Majumder, partner and consultant at Positive Vibes Consulting & Advisory.

A basic principle to follow when investing in a debt fund is to match the investment horizon with the average portfolio maturity of the fund category. If an individual’s investment horizon, for example, is one to three years, he can look at short-duration funds.

“After Sebi’s categorisation of mutual funds, fund managers can change the average maturity of gilt funds depending on the interest rate calls. But as the categorisation has recently happened, we don’t have track records of funds that have been able to perform under different interest rate scenarios,” says Kaustubh Belapurkar, director, fund research, Morningstar Investment Advisor India. 

If you are a retail investor, you can allocate a portion of the portfolio to the medium- to long-term debt fund category instead of gilt funds. “Funds in this category have an average portfolio maturity between four and seven years and hold gilts along with other papers. They may not shoot up like gilts but an investor won’t face high volatility either,” says Suresh Sada­gopan, founder, Ladder7 Financial Advisories.