Gilt funds have performed very well, can I invest now?

Gilt mutual funds money growing

What are Gilt funds?

Mutual funds which invest only in Government of India bonds are Gilt funds. These bonds are highly liquid and are free from default risk as the government can always print rupees at will. Gilt funds have been in existence for over 20 years. 

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Performance of Gilt funds

If you check out the performance of Gilt funds, you will find that the last 1-year, 3-year and 5-year performance are all very good around 10% per annum. You will get tempted to conclude that the future performance will be similar. However, you need to understand more about Gilt funds before investing. I have used data for a select set of 6 Gilt funds and 1 Gilt fund with constant 10 year maturity. The selection is based on funds which have been in existence for at least 15 years with a decent assets under management.

Interest Rate Risk

Gilt funds are exposed to interest rate risk. If the interest rate increases, the fund NAV will decrease. Why does this happen? Let us consider the below 3 bonds with maturity period 1 year, 5 years and 10 years. The current interest rate is 7%.

You have purchased 1 bond each of A, B and C. Let us assume that due to market changes, the interest rates change. We will consider case 1 where interest rate increases by 1% and case 2 where interest rate decreases by 1%. 

Case 1: When interest rate increases by 1%, your bond will still pay you the same maturity amount at the contracted rate of 7%. However, if you purchase a new bond, it will give you an interest rate of 8%. What will be the current value of the bonds which you have already purchased? It will decrease. The below table shows the current value of your bonds

The value of Bond A decreases the least due to the short maturity period of 1 year, which the Bond C with the longest maturity is the biggest loser.

Case2: When interest rate decreases by 1%, the reverse happens and the current value of the bonds increase as shown below:

Value of Bond A rises the least and the Bond C rises the most. This is due to the difference in the remaining duration.

From these cases, it is clear that the longer remaining duration, the higher the interest rate risk.


The exposure to interest rate risk makes the Gilt funds volatile. This is because mutual funds need to mark to market their holdings on a daily basis. The NAV of the funds need to reflect the current market value of the underlying securities held in the fund. From the list of gilt funds considered, My preference is for the ones with lower volatility.

Rolling returns

The current snapshot of returns does not reveal how the performance had been for holding period of 1 year. To understand the returns when the fund was purchased for example on 01 Jan 2015 and sold on 01 Jan 2016, you need to check the 1 year rolling return which will show the performance of the fund for every 1 year holding period possible. 

There have been 1-year periods during which the returns have been negative. This has happened in 2005, 2014 and 2018 when interest rates have moved up. This makes the holding period of 1 year risky, especially at the bottom of the interest rate cycle such as now. Let us check out 3 year rolling returns.

The 3 year holding period is much better with always positive returns for all funds considered. A minimum holding period of 3 years is required for investing in Gilt funds.

Is it a good time to invest in Gilt funds now?

In my opinion, we are at the bottom of the interest rate cycle. I believe that interest rates are less likely to move lower from here as the inflation is moving up. RBI has kept the Repo rates unchanged for now in the last meeting. As the economy improves post COVID, inflation is likely to remain steady and higher than 6%. In my opinion, interest rates may move up after 6 month to 1 year. Hence any investment in Gilt funds now may see short term negative movement. Hence invest in long duration Gilt funds with caution.


It is prudent to remain invested in short duration debt funds which are predominantly gilt or good rated commercial papers for the next 6 months to a year. Gilt funds could be good investment once the interest rates have moved up. If you are considering investments in Gilt funds now, you need to remain invested in it for at least 3 years and be prepared for short term negative returns.

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