I am looking a fund for short-term investment of around four to six months. Which is a better option-short-term debt funds or short-term gilt funds?
Yogesh
Both categories of funds are ideal for short-term investment but a lot depends on the risk taking ability of the individual. Short-term gilt funds restrict itself only to government securities and treasury bills. On the other hand, short-term debt funds invest in all sorts of debt instruments like corporate bonds, commercial papers including gilt and treasury bills.
Short-term debt funds enjoy a higher coupon income of corporate bonds. Though they mostly invest in high quality bonds but even then they are not completely free from credit risk. Thus they pay higher coupon vis-à-vis gilts. Whereas, short-term gilt funds are free of credit risk because gilts are sovereign instruments (fully backed by the government).
Also, short-term gilt funds have better chance of playing interest rate risk due to higher liquidity in the secondary market for gilts. This also translates into higher returns in times of declining interest rates. For instance in the mid-year rally of 2003 (March-September 2003), short-term gilt funds delivered 4.46 per cent return, whereas short-term debt funds gained 3.89 per cent. This was mainly because short-term gilt funds have maintained a slightly higher average maturity than the short-term debt funds in the same period.
However, the reverse is also true in case bond market turns volatile (as it is currently) or interest rates firm up. For instance, in the past 3 months, the category of short-term debt funds were up 1.11 per cent and the short-term gilt funds managed to gain 0.79 per cent, as on February 17, 2004.
The greater liquidity of gilts also translates into higher volatility for the short-term gilt fund investors. For instance, in the past eighteen months, the standard deviation of short-term gilt funds was 0.28 per cent as against the short-term debt fund's standard deviation of 0.10 per cent. Thus, if you can withstand volatility then only consider investing in a short-term gilt fund otherwise short-term debt fund is a better option due to the higher coupon income and stability.
In the past one year, if you had stayed invested in a short-term gilt fund for at least six months, you would have gained 3.82 per cent on an average. On the other hand, your return would have been slightly lower (3.3 per cent) in case of short-term debt funds over the same period. Of course one has to compromise between risk and return. Thus, evaluate your risk taking ability and act accordingly. But as these investments are generally done for shorter period of time, we would suggest you to go for the short-term debt fund for its diversified investment universe and low volatility.
This article was originally published on April 09, 2004.
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