Here is a comparison between three types of funds (by choosing one in each category): Short-term gilts funds, Long-term gilt funds and ultra short-term gilt funds. In this post, I would like to reiterate a point made earlier about staying away from gilt funds unless we know how to trade in accordance with interest cycle movements.
Gilts do not have any credit risk. That does not mean they are devoid of risk. The NAV of gilt funds are marked to market. That is, the value of the bonds in the portfolio will equal the current market value. So when interest rates increase, the NAV falls and when rates decrease, the NAV increases. To understand this in detail, please refer to Understanding Interest Rate Risk in Debt Mutual Funds.
Long-term gilt funds hold GOI bonds that mature after several years: Above 4.5 years if we use Value Research classification.
Short-term gilt funds: same as above with maturity below 4.5 years.
Ultra-short term: Funds can invest in any type of bond – GOI, corporate debentures, PSU debentures, bank certificate of deposits etc.
The advantage with this class is that, both interest rate risk and credit risk is minimised. The assumption here is that the fund manager does not buy too much of any one corporate or GOI bond like JP Morgan did. Read more: Lessons from the JP Morgan – Amtek Auto Debacle.
I have earlier shown using last 12-year annual returns that, although the gilt funds produce spectacular returns for a year or two, unless the investor books profit periodically, the gains would be erased by the interest cycle. Therefore, when it comes to investing in debt mutual funds: slow and steady wins the race!
Instead of returns, let us at how the NAV of following (randomly selected) funds evolve for different periods using thefundoo’s awesome return comparison tool
short-term gilt fund – SBI Magnum Gilt Short-term plan (green line)
long-term gilt fund – Baroda Pioneer Gilt (violet)
ultra-short-term fund – HDFC Cash Management Treasury Advantage Plan. (yellow)
Click on the images to enlarge.
- There is not much difference between ultra short-term and short-term gilt funds in terms of returns. The sharp gains made by short-term gilts are are gradually erased in time. So I see no point in having them part of a investment portfolio.
- Long-term gilts are a terrible choice for a long-term portfolio.
- Short-term gilts are better for opportunistic investing to take advantage of rate movements than long-term gilts. We will not gain as much as long-term gilts when rate come down, but we will also not lose as much.
Sankaran Naren, the CIO of ICICI Pru AMC, made an interesting remark in an interview: ‘I prefer to trade in fixed income and invest in equity’. I guess he was referring to timing the bond market and buying long-term gilts funds before the rate cuts begin, and exiting before the rates start to increase again.
Thanks to Mr. Raghu Ramamurthy for encouraging me to make this comparison.