Back to the gilt floor

Government securities (G-secs), or gilts, are once again looking attractive as an investment option. The reason: the yield on the 10-year G-sec has nearly doubled since July 2004 and is currently hovering at 9 per cent. But a decent interest income isn’t all that gilts offer; they also hold the promise of capital gains if interest rates fall, which many analysts say is a distinct possibility. Says Sanjay Matai, Promoter, The Wealth Architects: “Risk-averse investors, who do not want to park their money for long periods in bank fixed deposits or National Savings Certificates, now have another safe investment option in G-secs.”

Safety of investment is the biggest draw for gilts. Says Akhilesh Singh, Business Head, Emkay Global Financial Services: “Gilts are sovereign securities issued by the Reserve Bank of India (RBI) and are secure instruments.” Then, they come in a multitude of tenures that range from less than a year to 25 years. Investors can hold gilts till maturity and get a periodic coupon payment, and the principal amount on maturity.

The rate effect
But it’s the prospect of capital gains that makes investing in gilts all the more exciting. Since interest rates and G-sec prices have an inverse relationship, capital gains can accrue to the investor if interest rates fall and vice versa.

So, should you be investing in gilts now? Says K. Ramkumar, Head (Fixed Income), Sundaram BNP Paribas Mutual: “The right time to invest in gilts depends on the view one takes of the economic scenario ahead. Interest rates have gone up significantly over the last 2-3 years and may now have a negative effect on growth. And inflation, which soared on the back of rising international crude prices, is expected to climb down, as crude prices have cooled off sharply.

This may prompt RBI to review rates and trigger rate cuts to provide a stimulus to growth.” Agrees Himanshu Kohli, Founder Partner, Client Associates: “Since debt yields have gone up, it’s a good time to look at investments in gilts. If interest rates fall, existing bonds will begin to trade at a premium, and investors can then sell them at a profit. If one thinks that interest rates have peaked, then one may consider investing in medium- to long-term gilts.”

But what’s the best strategy to follow? Market analysts suggest that investments in gilts should be made in a phased manner as the direction that interest rates will take is still not clear. Says Kohli: “Investing in stages will give investors leeway to make fresh investments and average out the portfolio if interest rates surge going forward.

Also, the investment strategy should vary for each investor depending on his profile. For example, a moderate investor should enter gilts systematically over a one-year period and increase his allocation if rates harden; he should reduce his exposure if interest rates soften from those levels. On the other hand, aggressive investors should look at a higher allocation of their debt corpus to gilts and can buy products with a three-year maturity.” Last year, on average, gilts gave 6-7 per cent annualised returns.

How gilt funds stack up against government-backed fixed investments. RBI Bond Lock-in: 6 years Liquidity: None Interest rate: 8% Payment frequency: Semi-annually Taxation: Interest taxed No TDS for interest less than or equal to Rs 10,000 Capital appreciation: Principal+interest income realised at maturity Volatility: None Investment limit: None PPF Lock-in: 15 years Liquidity: Withdrawal of up to 50% of the sum allowed after 5 years Interest rate: 8% Payment frequency: Annual Taxation: Benefit available u/s 80C Capital appreciation: Principal+income realised at maturity Volatility: None Investment limit: Rs 70,000 per annum Gilt Funds Lock-in: None Liquidity: Daily buying and selling Income: Variable income Payment frequency: Periodic Taxation: Indexation benefit on growth option Dividend tax at 12.5% Capital appreciation: Capital appreciation+interest income Volatility: Sensitive to interest rate changes Investment limit: None

Ascertain absolute returns
For retail investors, gilt funds are a convenient way of investing in gilts. Says Ramkumar: “It is difficult to invest directly in G-secs due to the large size of lots traded in the wholesale debt market. In the retail segment, volumes are quite low and the bid-ask spreads quite wide.

The absence of liquidity makes it difficult to sell the securities in times of need. Given the convenience of buying and selling G-secs through MFs, gilt funds should be the preferred way of investing in G-secs.” Gilt funds have generated returns of 7-8 per cent over the last one year.

Individual investors also need to know that prices of gilts are guided by market sentiment, which, in turn, is driven by factors such as demand and supply of gilt paper, interest rates, foreign exchange movements, RBI auctions and government borrowings, all of which keep changing over a length of time. As a result, while interest income is guaranteed in gilts, the absolute returns in the hands of investors are not. Says Matai: “Interest rates and G-sec prices have an inverse relationship. Therefore, if interest rates move up, there will be capital depreciation. Depending on the rate of increase, the depreciation could even be more than the interest income, thus, resulting in overall loss. Also, gilts with longer tenures are volatile, while the ones with shorter tenures are stable though they offer lower yields.”