What are gilt funds?

These are mutual fund schemes that invest in government securities (G-Secs), issued by the Reserve Bank of India on behalf of the government.

Being sovereign papers, these do not expose investors to credit risk. Conventional debt funds invest in debt instruments across the board, but gilt funds invest only in government bonds. The G-Sec market is largely dominated by institutional investors and gilt funds are an avenue for retail investors to participate in the market.

Who should invest?
These are ideal for those who want more safety for their investments or are risk-averse and, at the same time, are looking for reasonable returns on their money. In the present scenario, fund managers advise investing for medium (3-5 years) to long-term (above 5 years). However, invest in tranches to avoid over-exposure and associated risks. According to mutual fund rating agency, Value Research, medium and long-term gilt funds gave returns of 3.84 per cent for the year ended May 30. In the short-term (less than a year), they have returned 4.18 per cent.

When should you invest?
These are a good option when inflation is near its peak and the RBI is not likely to raise interest rates immediately. There is an inverse relationship between bond prices and interest rates — a fall in interest rates leads to a rise in bond prices and vice-versa. Since rates are expected to peak soon, we may see a dip in interest rates in six months. That will be the ideal time to invest in these funds.

Are gilt funds completely risk-free?
No, these don’t even assure returns like those offered by bank fixed deposits and savings accounts. Factors such as fiscal deficit and the country’s debt burden weigh on the performance of G-Secs and hence, gilt funds. Investment in gilt funds is subject to interest rate risks. When interest rates rise, prices of government securities fall, adversely impacting the performance of gilt funds. Typically, higher the fund’s average maturity, higher the volatility. Another disadvantage is that they are highly illiquid. These funds invest in G-Secs, which are not actively traded.

What are the applicable charges?
Gilt funds charge an exit load of one per cent if you redeem the units in less than a year.

How are investments taxed?
If you sell the unit in less than a year, the returns are added to your income and taxed according to the slab you fall under (short-term capital gains tax). Long-term capital gains tax is 10 per cent without indexation and 20 per cent with indexation. These are debt funds and not subject to the securities transaction tax.