Gilt Mutual Fund User Guide: When and How to use them

Published: June 1, 2019 at 11:11 am

Last Updated on December 25, 2023 at 7:54 pm

This is a user guide on gilt mutual funds (a debt fund that invests in govt bonds). When to use them & how to use them for maximum benefits. Let us start with the basics, but before we do, do check out these two free e-books: MF FAQ for beginners and if you are new to debt mutual funds:  A Beginner’s Guide To Investing in Debt Mutual Funds

So let us now start with the basics. As per the current definition, a gilt mutual fund is one that invests 80% of its assets in bonds issued by the state or central governments or RBI. These are known as Gsecs or gilts. These bonds can have any maturity from days to decades!

Did you know: The term gilt comes from British government bonds that ad gilded edges! You may have seen old books in the library or some diaries with golden color on the side when the pages are stacked together.

A second category is a gilt fund with a constant 10-year maturity. This will invest 80% of its assets in Gsecs with a 10-year maturity. Since this bond acts as a benchmark for determining long-term small savings schemes like PPF, this debt fund can be used to track long term interest movements.

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The rest 20% in both funds can be in any kind of bond although it is expected that mutual funds will have the sense to invest that only in cash and money market mutual instruments. However, sense might be too much to expect from them and we might well see a credit default crisis in a gilt fund also. After all, we have seen this in a liquid fund, arbitrate fund, dynamic bond fund, ultra short term fund.

Gilt Mutual Fund User Guide: When and How to use them

So please be aware upfront that if you want to invest in gilt funds because you are scared of credit defaults, then the risk is only lower here, not absent. Also, there is no free lunch. If you want to eliminate one risk, you will have to take on another. Do not assume gilt mutual funds are safer!

A quick introduction to the two main types of debt mutual fund risk. Credit rating risk: The NAV falls and rather steeply when the bond issuer delays or defaults on interest payment or if the financials of the issuer has worsened and no one wants to buy the bonds. Sadly, even if the rating agencies have degraded bonds, mutual funds need not mark down the NAV if they have reached an agreement with the issuer. This is shady and SEBI must immediately ban it. See: Eroding trust: Are mutual funds really market-linked products?

While credit rating risk will affect 20% of a gilt mutual funds portfolio, the rest will be subject to interest rate risk. While credit risk is like a volcano, dormant, calm and picturesque for weeks, months, years and deadly all of a sudden, interest risk is like traveling on a stormy sea where the boat rocks constantly. So this means the NAV of a gilt fund can move up or down significantly.

Sometimes the NAV will shoot up for weeks, sometimes down for weeks and sometimes nowhere. This means that our returns can fluctuate quite a bit over the short-term and may disappoint over the long term. There is more to these risks than what I have mentioned above. Please consult: Understanding Interest Rate Risk in Debt Mutual Funds and Understanding Credit Rating Risk in Debt Mutual Funds

The current gilt mutual fund space

There are currently 26 gilt mutual funds with two ETFs (from Reliance and LIC). The average portfolio maturity ranges from 4.5 to 12.8 years. Higher the average portfolio maturity higher will be the sensitivity to interest rate changes and associated supply and demand (often before the rate change event).

Sadly, these mutual funds keep changing colour. A fund holding 12Y old bonds today may suddenly switch 1Y old bonds or vice versa and this can pretty frustrating to the investor. In other words, the gilt fund would often try and act as a dynamic bond fund – try to buy long term bonds before rates fall (so that existing bond prices rise) and buy short term bonds before rates increase.

Overall, this does have the desired effect of lower volatility in the NAV but can be frustrating to the investor depending on when they enter the fund. Also, please recognize that it is stupidity to use star ratings to buy gilt funds or any fund! A fund holding long term gilts may at times zoom resulting in higher stars than a fund holding short term gilts. If people look at the current rating without understanding context, they will suffer.

When to use gilt mutual funds?

As far as I know, there are currently no gilt funds that exclusively invests only in long term or only in short term Gsecs. So this is a big problem in portfolio design. Use gilt mutual funds only for 10-year plus goals as part of the debt allocation (duh!). It is better if the portfolio is rebalanced at least once a year.

Alternatively, tactical rebalancing can be considered. However, be warned that gilt funds can also crash alongside with equity (as in 2008). So do not expect anti-correlation

When to use gilt funds with 10-year constant duration?

If you like style purity in your gilt portfolio, then this a good choice. Use only for 15-year plus goal. Remember never ever take advice like, “match investment duration with the average maturity of debt fund” seriously. It is plain wrong: Poor Debt Fund Advice: Match Investment Horizon With Fund Maturity Profile. This fund will typically be more volatile than plain gilt funds, so rebalancing will help. There are only four such funds with  SBI Magnum Constant Maturity Fund having the highest AUM of 430 crores. The rest are way too small. All funds in this category are only a year old.

The SBI fund shown below changed from a short-term gilt fund to a 10Y constant maturity fund in May 2018. Can you notice how the volatility in the NAV suddenly increases after the change?

SBI Magnum Constant Maturity Gilt Fund

How to buy a gilt mutual fund

  1. Choose a fund with a reasonable AUM (say 400 Crores +). So this leaves us with (at present AUM levels, in descending order):
    • SBI Magnum Gilt Fund
    • HDFC Gilt Fund
    • ICICI Prudential Gilt Fund
    • Reliance Gilt Securities Fund
    • UTI Gilt Fund
    • Kotak Gilt Investment
    • IDFC Government Securities Fund
    • DSP Government Securities Fund
  2. Do not go by star ratings, choose 2-3 funds, read the scheme document to check if the investment strategy makes any sense. It will usually not as AMCs are interested in stuffing these with every possibility under the sun.
  3. Look where the fund will invest that 20%. It must be in money market instruments, repo, reverse repo, and CBLOs. These are very short term bonds. Read more: Worried about risk in debt mutual funds? Park your money in overnight mutual funds.
  4. Note that many of these funds will use derivatives to reduce interest rate risks.
  5. Pick a fund whose scheme document you can half understand with low risk 20% investments. If the 20% column in the asset allocation table says “medium to high”, avoid.

Examples of 20% risk profile:

  1. UTI Gilt fund: 20% –> Low
  2. ICICI Gilt Fund 20% –> Low to Medium
  3. HDFC Gilt Fund 20% —> Medium to high


Gilt funds will work only if you, as usual, aware of associated risks and manage portfolio risks. What do you think? Will you consider these funds? Share your views in the comments section.

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