I would like to know whether any fresh rate cuts by RBI (which are highly anticipated) will provide any recovery to Gilt Funds? My gilt fund investments have turned negative since they were last hit on January 07. Please advice.
-Naresh Mody
Gilt funds invest in government securities (G-Secs) including Central Government Dated Securities, State Government Securities and Treasury Bills. Being at the end of the maturity spectrum, they are very sensitive to interest rate changes.
When interest rates fall, the yields of government securities also fall and in turn their prices rise. When interest rates are on the rise, their yields rise and prices fall. Yields and bond prices move in opposite direction. Hence, gilt funds do well in a falling interest rate scenario.
The yields of gilts are dependent not only on the interest rate outlook but are also a function of demand and supply. The fall in the return of gilt funds on January 7, 2009 was due to a rise in the 10-year GOI yield that stemmed from the government's announcing a $10 billion additional borrowing plan on that day. This move increased the supply of gilts and hence yields rose.
If there are any fresh rate cuts in the future then the result would be decreasing yields and increasing bond prices. This move will benefit the gilt funds.
This article was originally published on April 07, 2009.
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