What is the risk involved in putting all my savings in a government security (gilt) fund? How safe are these mutual fund schemes?
It's heartening to know that before taking a plunge into an investment avenue, you are keen to assess its risk-reward profile. As is obvious from the name, a government security fund will invest all your money in securities issued by central and state governments. These are also known as gilts. Gilts are a kind of borrowing from the public and are issued for a defined period of time. These are the safest lending one can do, as the borrower is the Government of India, which guarantees the principal as well as the interest.
So, while credit risk is not a problem at all, there is definitely an interest rate risk. Why is that? Being actively traded, government securities' response to changes in interest rates is the sharpest. This brings about fluctuations in the NAV of gilt funds too. This is less pronounced in the case of income funds, which invest in corporate bonds too. For example, the standard deviation—a measure of fund's volatility—for income funds, ranges from 0.35-0.84 per cent. For gilt funds, this lies between 1.24 to 1.62 per cent.
This volatility can be a big source of gains when conditions are right. In an upbeat market, gilt funds tend to gain more than income funds. In 2001, when equities were in a slump, income fund investors earned a return as high as 15.73 per cent while gilt fund investors took home a whopping 25 per cent return.
Keeping in view their risk-return profile, prudent investing demands that you spread your money across different investment avenues. Hence we would not suggest that you stash away all your savings in a gilt fund. Do give room to other kinds of funds as well.