Time to look at Gilt Fund

Gilt fund are fund which invest in Government of India Securities. These are safest instruments in India with sovereign rating. There is no default risk in Gilt.

Risk profile – Moderate Risk

These instrument are subject to interest rate risk. They work inversely to movement in interest rate. If we buy 10 year GSEC paper @ 8.82% today and interest rate moves up Gilt prices will come down and vice versa. As government finances are in bad shape due to rise in fuel subsidy they will have to aggressively borrow in next six month. Market is factoring in aggressive borrowing and hence yield has gone up from 8.30% to 8.82%. This may further go up to 9.0%.

If we buy @9.0% 10 year Gsec paper and if interest rate come down by 1.0% in next 1 year we will have paper which is earning 1% more for next 9 years, which will be converted into premium for these paper by 6% to adjust to fall in interest rate. So return will be carry of 9.0% and capital gain of 6% which makes it 15%. In case of interest rate going up by 1% we will have 9%-6% = 3%.

In our opinion we are nearing the peak and any further rate hike will be detrimental to growth. Also there are imminent signs of slowdown. We would advise you to enter these funds in systematic manner.

Our advice is to look at combination of liquid plus / short term / Gsec funds in these high interest rate environment.

After peaking out of rates there are two possibilities.

1.       Fall in interest rate like 2008 where commodity prices come off sharply and interest rate come off sharply. In this period Gilt fund delivered 28-40% return in one year. This is less likely scenario.

2.       Fall in interest rate over next 2-3 years where interest rate cam off slowly and return in gilt fund was in excess of 15% for next three years.

This is time to avoid Fixed deposits as banks will go ahead and invest these money in such instrument to make capital gain.