Safe bet: investors should look for less volatile medium-term gilt funds

Motilal Oswal Asset Management Company has launched the 5-year G-Sec Exchange Traded Fund (ETF). At a time when gilt funds with 10-year constant duration are showing a one-year category average return of 12.4 per cent, this new fund offer is sure to garner investor interest.

Sanjay Kumar Singh | Business Standard
27nd November

All gilt funds are attracting investor interest now for two reasons. One, they invest in government securities and, hence, eliminate credit risk — something debt fund investors have been worried about for a while now. Past re-turns have also been sound. In a decli-n-ing interest-rate scenario (the 10-year G-Sec has declined 62 basis points over the past year), the returns from these products, which invest in longer-duration bonds, tend to be good.

“Conservative investors who want safety and post-tax returns that are better than from bank fixed deposits, may invest in gilt funds,” says Arnav Pandya, Mumbai-based certified financial planner and founder, Moneyeduschool.

One variation of gilt funds is the 10-year constant-duration gilt fund. Irrespective of the interest-rate outlook, these funds maintain a duration of 10 years. The fund manager does not take active duration calls here. “The risk of such calls going wrong gets eliminated. However, the alpha that a fund manager can generate by taking such calls is also not available,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Both these categories carry considerable interest-rate risk. “The returns from these funds can be negative in a rising interest-rate environment,” says Deepesh Raghaw, founder, PersonalFi nancePlan, a Securities and Exchange Board of India-registered investment advisor. Investors need to enter these categories with at least a 5-10-year horizon to overcome interest-rate risk.

Motilal Oswal’s new product, which will track the Nifty Five-Year Benchmark G-sec Index, is also a constant-duration product. The constant-duration gilt funds available today are constructed using 10-year G-Secs. This is a medium-duration product. “We like the five-year gilt segment because it is the most liquid after the 10-year. It is also considerably less risky than the 10-year G-Sec. It is between the short and the long end of the yield curve. Investors get some premium, but they are also not exposed to too much interest-rate risk,” says Pratik Oswal, head of passive funds, Motilal Oswal Asset Management.

Being passively managed, it will also eliminate risk of interest-rate calls going wrong. “Timing the interest rate cycle is a lot harder than people think,” adds Oswal.

Investors will get the benefit of taxation at 20 per cent with indexation if they hold the ETF for more than three years. Since it will be listed on the exchange, investors will be able to exit at any point during the day. Unlike a fixed maturity product (FMP), it is not a roll-down product (it does not expire on a fixed date).

Investors must, however, watch out for liquidity in the ETF. “If there is a considerable difference between the net asset value and the market price, you could lose out on a part of the return,” says Raghaw.

Its expense ratio is only 22 basis points. Investors must use a low- or zero-cost brokerage to truly enjoy this low-cost advantage. Those who wish to eliminate credit risk, and want a relatively lower-volatility product may opt for this ETF, provided they have a long-term horizon. “Invest for at least five years in it,” says Pandya.

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