Enter constant maturity gilt ETFs with 5-year plan, say analysts

Conservative investors looking to lock in returns should opt for target maturity ETFs/index funds

The new fund offer (NFO) of Nippon India ETF (exchange-traded fund) 5-Year Gilt Fund, which was launched on March 22, ends on Friday. Earlier, Motilal Oswal had also launched a 5-Year G-Sec ETF. In recent times, fund houses like Edelweiss and IDFC have also launched passive index funds and ETFs that invest in AAA PSU bonds, state development loans (SDLs), and government securities (G-Secs). Investors should understand the characteristics of these categories and their own risk profile before making a choice.

Five-year gilt is in a sweet spot

Nippon’s and Motilal’s funds are constant maturity ones. Unlike target maturity funds, they won’t wind up on a fixed day. They invest in an index made up of G-Secs that mature in five years.

Fund houses are launching funds investing in five-year G-Secs because the yield, at around 5.7-5.8 per cent, is more attractive than on one-two-year papers. “Yields have moved up. The spread between the one-year and five-year gilt, which over the long-term averages 60 basis points (bps), is today at about 180 bps,” says Arun Sundaresan, head-product management, Nippon India Mutual Fund.

Both credit and liquidity risk are low in these funds. The low expense ratio (10 bps in the case of the Nippon Fund) also works in their favour.  

Interest-rate risk

Being medium-duration funds, they will be susceptible to interest-rate risk. Fund managers, however, feel interest rates may not rise much from current levels. “Central banks are committed to supporting low interest rates. The markets could take yields up based on inflation expectations. But our view is that yields have already gone up significantly and may rise only marginally from here,” says Sundaresan.

Investors could lose a part of their gains if interest rates rise. But, fund houses say, owing to the relatively good coupon on five-year bonds, and the indexation benefit on long-term capital gains (as opposed to being taxed at slab rate), investors will end up with better returns than they could get from many fixed-income products that get taxed at the slab rate.

Returns won’t be linear  

Investors who want a medium-duration debt product with low credit risk may go for them. “They are suited for those who can invest for around five years and don’t have a defined investment horizon,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.    

However, returns will not be linear. “Returns will only come over an entire cycle. They could be lower than the current yield, while interest rates are rising over the next six months to one year. Investors will make up for the losses when rates fall,” says Arun Kumar, head of research, Fundsindia.com. Counter the expected volatility by investing with a five-year horizon.  

Target maturity funds for risk-averse

Conservative investors, who have recently migrated from fixed deposits to debt funds, and want predictable returns, may opt for target-maturity funds. “They allow investors to target a certain return, which is the yield to maturity minus the expense ratio. If an investor holds these funds to maturity, he will get almost a fixed-deposit like experience,” says Dhawan.