The verdict is unanimous: step up your exposure as rates look to be on the way down, but bet only on managed funds

Expect safe landing with gilt fund parachute

The verdict is unanimous: step up your exposure as rates look to be on the way down, but bet only on managed funds

Gilt funds which invest in government securities are headed for some extra dollops of shine. An unmistakable buzz swirling around a likely rate cut only means the outlook is getting much sunnier. The reason is hard to miss — a high return scenario seems to be the alluring bet. The funds in question are considered as one of the most secure investment tools riding the rate cycle since default risks here are barely any. “It’s a good way of investing because interest rates are expected to fall, so these can lock in at the current net asset value (NAV). In the event of a fall, they will be able to exit at a later stage profitably,” pointed out N S Venkatesh, chief general manager (treasury), IDBI Bank. The crawling economic growth, which is down from a near double digit level not long ago, is only adding to the urgency of a softer policy. But inflation is still playing a spoiler. “The Reserve Bank of India (RBI) will definitely ease rates once the prices are brought under control,” added Venkatesh, who expects a rate reduction of at least 25 basis points (bps) in the upcoming policy review on October 30. Open market operations (OMOs) play a part as more of these can lead to gilt yields sliding further. Also, the Street expects the quantum and guidance of a probable rate cut to be a major decider. According to regulatory data, the average pre-tax return for 1-year gilt funds is currently at 10% and for the top 10 in the league, it stands at around 14%. (Please refer to the table). Lakshmi Iyer, head, fixed income at Kotak Mutual Fund, too is sanguine about gilt funds, saying the investment makes sense because of an expected fall in rates. She expects the central bank to bring down rates by 50 bps by the end of this financial year. “If that is going to be the case, then the 10-year benchmark bond yield also should react favourably. It should be in the 7.75-8% kind of a range,” Iyer added. Gilt funds are best suited for medium to long term opportunistic investment in a steep yield curve scenario. These work like this. Yields and interest rates move in tandem, which means the former comes down when rates start coming off. However, yields and the bond price share an inverse relationship, which explains why bond prices go up when rates come down and vice versa. So, when yields tumble, gilt prices start moving up, thus pushing up the NAV. Suresh Sadgopan, who runs Ladder7 Financial Advisories, throws in a rider: “It is definitely an option for investors in the reversing interest rate cycle. But for a retail investor, it is better to take gilt fund exposure through managed funds, considering the interest rate sensitivity of the fund.” Income funds like SBI, IDBI and Kotak dynamic bond funds carry a 35-40% exposure towards gilt. Take it from market observers, who are all for re-scheduling one’s portfolio with an adequate exposure to gilt funds.