Gilt Funds vs. Corporate Bond Funds: A Comparison

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  • 03 Jan 2024
Gilt Funds vs. Corporate Bond Funds: A Comparison

Gilt funds are mutual funds that predominantly invest in government securities. Government security, also known as a G-Sec, is a debt instrument issued by the Central Government or State Governments to raise funds for public expenditure.

The issuance of G-Secs is facilitated through India’s central bank, the Reserve Bank of India (RBI). The term “gilt” is used because these securities carry no default risk, thanks to their sovereign guarantee and high credit rating.

The common types of gilt funds are as follows:

1. Gilt Fund

This category of gilt funds actively invests in government securities with varying maturities. For instance, funds within this classification can expose themselves to short-duration papers, featuring maturities ranging from 1 to 3 years. They can also position their investments in papers with maturity approximately ranging from 10 to 15 years.

As per SEBI’s mandate, this fund type must allocate a minimum of 80% of its portfolio exclusively to government securities. Mutual funds typically allocate the remaining 20% to debt instruments such as T-bills, cash and cash equivalent securities, certificates of deposit, commercial papers, and other eligible options.

2. Gilt Fund With 10-year Constant Maturity

These funds maintain exposure to government securities with 10-year durations, as per SEBI’s categorization mandate. Similar to the aforementioned gilt funds, this category requires a minimum allocation of 80% of its portfolio exclusively to government securities.

Here are some essential features of gilt funds:

1. Investment in Government Securities

Gilt funds primarily invest in government securities, including central government bonds and state government bonds. These securities are considered safe as the government backs them.

2. Low Credit Risk

Since gilt funds invest in government bonds, which are backed by the sovereign, they carry minimal credit risk. The likelihood of default on government securities is considered extremely low.

3. Stable Returns

Gilt funds provide stable and predictable returns over the long term. The focus on government securities contributes to the stability of these funds.

A corporate bond fund actively invests over 80% of its financial assets in corporate bonds. Businesses sell these bonds to finance various short-term expenses, including working capital needs, advertising, insurance premium payments, and more.

A corporate bond fund primarily invests in:

  1. Companies with very high CRISIL credit ratings (AA+), including Navratnas and public sector firms
  2. Firms with slightly lower credit ratings

Here are some of the key features of corporate bond funds:

1. Investment in Corporate Bonds

Corporate bond funds invest in bonds that corporations issue. These bonds represent the debt obligations of companies seeking capital and pay periodic interest to investors.

2. Can Offer Potentially Higher Returns

These funds typically offer higher returns than gilt funds but also have higher risk. This is because corporate bonds are issued by companies, which are more likely to default on their debt than governments.

3. High Liquidity

These funds are generally more liquid than individual corporate bonds, which means they can be easily bought and sold. This makes them a good choice for investors who need to access their money quickly.

Now that you know the meaning and features of gilt funds and corporate bond funds, let’s compare them on key parameters. The table below compares them in various aspects:

Aspects Gilt Funds Corporate Bond Funds
Underlying SecuritiesPrimarily invests in government securitiesMainly invests in bonds issued by corporations
RiskLow due to government backingModerate to high as it’s issued by corporation
Credit riskMinimal as government securities are secureHigh as corporate bonds are likely to default
ReturnsGenerally lower compared to corporate bond fundsPotentially higher than gilt funds
Investor profileSuited for conservative investorsSuitable for investors with moderately higher risk appetite

Choosing between gilt funds and corporate bond funds depends on your financial objectives, risk tolerance, and investment preferences. Here are some factors to consider when deciding between gilt funds and corporate bond funds:

1. Risk Tolerance

Gilt funds may be more suitable if you have a low-risk tolerance and prefer capital preservation. They are considered low-risk due to their investment in government securities. You can consider them if you have a moderate risk tolerance and can take a higher risk for higher returns.

2. Investment Horizon

Gilt funds are often suitable for long-term investors seeking stability and consistent, albeit potentially lower, returns over time. Corporate bond funds may be appropriate for you if you have a medium to long-term horizon looking to balance income generation and capital appreciation.

3. Return Expectations

Gilt funds generally offer lower returns compared to corporate bond funds. If your aim is to preserve capital and you are content with modest returns, gilt funds might align with your expectations. Corporate bond funds could provide the income and growth you're looking for if you seek higher potential returns and can take on some level of credit risk.

In Conclusion

Ultimately, the decision between gilt and corporate bond funds should align with your financial objectives and risk preferences. Several investors choose to diversify their portfolios by including a mix of both asset classes to achieve a balanced and well-rounded investment strategy.

FAQs on Gilt Funds vs. Corporate Bond Funds

The best time in a falling interest rate regime. As interest rates decline, gilt funds tend to experience higher returns because the demand for government securities increases due to the higher interest rates they offer, causing bond prices to rise.

Yes, gilt funds are highly safe because they primarily invest in government securities.

Corporate bond funds are ideal for moderately high-risk investors who have an investment horizon of 2-3 years.

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