Gilt mutual funds invest in Government securities or bonds with varying maturities.The term Gilt also refers to the sovereign (Government of India) guarantee for these types of securities. Investors should know that, the Government guarantee is with respect to the credit risk of these securities; Gilt prices are subject to interest rate risk.
Bond prices are inversely related to interest rate movements; if interest rate moves downwards, bond prices increase and vice versa. Interest rate risk is directly related to maturity of debt securities. Longer the maturity, higher the interest rate risk; shorter the maturity, lower the interest rate risk.
Average maturities of underlying securities in long term gilt mutual funds can range between 15 to 30 years; these funds are highly sensitive to interest rate changes. Gilt mutual Funds can give negative short term returns if interest rate movement is unfavourable. However, over a sufficiently long investment horizon, in an environment of declining interest rates, long term gilt mutual funds can give good returns.
Average maturities of underlying securities in short term gilt funds can range between 5 to 7 years; therefore, the interest rate risk is significantly lower than the long term gilt mutual funds. Short term gilt mutual funds are less volatile than long term gilt mutual funds; they outperform long term gilt mutual funds in rising interest rate environment but underperform in declining interest environment.
Medium term gilt mutual funds invest in government securities which have intermediate maturity profiles; longer than short term gilt mutual funds, but shorter than long term gilt mutual funds. These funds combine the characteristics of both long term gilt mutual funds and short term gilt mutual funds. Medium term gilt mutual funds are less volatile compared to long term gilt mutual funds and at the same time, can give higher returns than short term gilt mutual funds in a favourable interest rate scenario. As such, these mutual funds are suitable for debt mutual fund investors with moderate risk tolerance levels.
Investors should have a sufficiently long investment horizon and some appetite for volatility in medium term or long term gilt mutual funds.
From a taxation viewpoint, gilt mutual funds are taxed just as debt mutual funds. Capital gains held for a period of less than 3 years are treated as short term capital gain and taxed as per the income tax rate of the investor. Capital gains on investments held for more than 3 years are treated as long term capital gains and taxed at 20% after allowing for indexation benefits. Dividends paid by the gilt mutual funds are though tax free in the hands of the investors, the scheme has to a pay dividend distribution tax (DDT) at the rate of 28.8% for individual investors and Hindu Undivided Families (HUF) and 34.6% in case of corporates.