Gilt Mutual Funds invest in Government securities or bonds with varying maturities. The etymology of the term “Gilt”can be traced back to colonial times when Government securities were issued on golden edged paper. The term Gilt also refers to the sovereign (Government of India) guarantee for these types of securities. Investors should know that, the Government guarantee is with respect to the credit risk of these securities; Gilt prices are subject to interest rate risk.
Bond prices are inversely related to interest rate movements; if interest rate moves downwards, bond prices increase and vice versa. Interest rate risk is directly related to maturity of debt securities. Debt funds investors lust note that longer the maturity, higher is the interest rate risk; shorter the maturity, lower is the interest rate risk.
You must read what are different types of debt mutual funds in India
Average maturities of underlying securities in long term gilt funds can range between 15 to 30 years; these funds are highly sensitive to interest rate changes. Therefore, gilt funds can give negative returns in the short term if interest rate movement is unfavourable. However, over a sufficiently long investment horizon, in an environment of declining interest rates, long term gilt funds can give good returns.
Please check the returns of long term gilt funds
Average maturities of underlying securities in short term gilt funds can range between 5 to 7 years; the interest risk of short term gilt fund is significantly lower than long term gilt funds. Short term gilt funds are less volatile than long term gilt funds; they outperform long term gilt funds in rising interest rate environment but underperform in declining interest environment.
Please check the returns of short term gilt funds
Medium term gilt funds invest in government securities which have intermediate maturity profiles; longer than short term gilt funds, but shorter than long term gilt funds. These funds combine the characteristics of both long term gilt and short term gilt funds. Medium term gilt funds are less volatile compared to long term gilt funds and at the same time, can give higher returns than short term gilt funds in a favourable interest rate scenario. As such, these funds are suitable for debt investors with moderate risk tolerance levels.
Investors should have a sufficiently long investment horizon and some appetite for volatility in medium term or long term if they are investing in gilt funds. From a taxation viewpoint, capital gains made on gilt funds held for a period of less than 3 years are taxed as per the income tax rate of the investor. Capital gains on investments held for more than 3 years are taxed at 20% after allowing for indexation benefits. Dividends paid by the gilt funds are tax free in the hands of the investors, but the scheme has a pay dividend distribution tax (DDT) at the rate 28.84% for individual investors and Hindu Undivided Families (HUF) and 34.6% for companies.