The anticipated rate cut has seen the clamour for gilt funds go up. The inflows into gilt funds is on the rise, with assets in October going up to Rs 1,018 crore compared with Rs 39 crore in September 2012, a whopping 2500 per cent rise during the month. Gilt funds are the only way for retail investors to participate with investments in government securities (G-Secs) as direct investments in G-Secs requires large sums, which is possible only for big institutions.
Gilt funds primarily invest in G-Secs issued by the Reserve Bank of India and in corporate bonds, zero-coupon bonds and treasury bills, certificates of deposit, commercial paper as well as derivative instruments like exchange-traded interest rate futures and interest rate swaps. The value of bonds of any kind is primarily influenced by the prevailing interest rates. If interest rates go down, the value of bonds goes up. The daily NAV of a gilt fund is calculated by valuing a variety of Government bonds, which a fund has invested in, and are traded in the market. As interest rates change, the value of the securities in which the scheme has invested, fluctuates as well. This, in turn, will be reflected in the changing value of the fund and it's NAV.
Long-term gilt funds have returned 11.54 per cent in the past year (see table: Riding the gilt wave) compared to 9.5 per cent by ultra short-term debt funds.
Is it the time to buy gilt?
The right time to invest in a gilt fund is when interest rates are near their peak levels, with inflation likely to go down. Moreover, economists predict growth when overcapacities get built up and there is a slowdown, gilt is the instrument to bet on. The last time such a frenzy to invest in gilt occurred in October 2008, in the wake of the global financial meltdown. And the ideal time-frame to invest in gilt should be two to four years.
What you need to be aware of when investing in gilt fund is that the value of your investment may go down due to interest rate fluctuations and mark-to-market formula of securities valuation. Yet, gilt funds are your best bet when it comes to gaining from the fall in interest rates.