If equity MF returns are negative will gilt MF returns be positive?

Published: April 17, 2021 at 10:26 am

Last Updated on August 30, 2021

In the second part of the FAQ on gilt mutual funds, we consider the correlation between equity and gilt movements. An analyst would calculate this using a correlation coefficient and create a matrix. This is not intuitive to the average investor. So we shall seek the answer to a simple, direct question: If equity MF returns are negative, will gilt MF returns be positive? And vice versa.

Since portfolio rebalancing is typically done once a year, we shall consider one-year rolling returns of the Nifty 50 TRI and the IBEX I-Sec Gilt Index from 30th June 1999. The same dates in both series are used to ensure uniformity in return calculation, and we get a total of 4968 returns.

When we speak of correlation between two asset classes, investors are too demanding in expectations. If they see the Nifty fall down for three days in a row, they expect gilts or gold to move for three days in a row. There are too many factors at play in different market segments for the asset class to perform synchronised swimming.

A one-year window is a reasonable, practical, but still, arbitrary window to look for “correlations”. Even before we look at the graph, we must understand that no “pattern” can be found at all times. Sometimes they will be correlated, and sometimes not.


Shown below are gilt 1Y returns (yellow dots) when Nifty 50 TRI returns are negative (blue dots). Typically when the market is “down”, we can expect some portfolio support from gilts, but not every year. This clustering of dots is essentially one rebalancing event for the individual investor. So over the last 22 years or so, there have been only 5-7 such opportunities.

Negative Nifty annual returns and corresponding gilt returns
Negative Nifty annual returns and corresponding gilt returns

The opposite, negative gilt returns and positive nifty returns are less frequent and happen when bond yields spike (the price of existing bonds drop).

Negative Gilt annual returns and corresponding Nifty returns
Negative Gilt annual returns and corresponding Nifty returns

So the correlation is not perfect but likely during strong events in the stock or bond market. This will give rebalancing opportunities from equity to gilt (+ve Nifty and -ve gilt annual return) or from gilt to equity (+ve gilt to -ve Nifty). Only investors who can understand the implications of such a wild swing in returns and initiate rebalancing will benefit by investing in gilts (or equity!). Now let us consider the rest of the questions from investors.

Q Role / Impact of fund manager in a gilt fund? A: In the constant maturity 10-year gilts, it is not as much as the portfolio bond tenure will always hover close to 10 years. All normal gilts funds are also dynamic bond funds. Some will aggressively change the average portfolio maturity, and some not so much. So the fund manager risk is quite high in a normal gilt fund.

Q In the same interval of time, can 2 gilt funds have different returns/risk? A: Quite possible because of the above reason.

Q In the long term, how is interest rate risk handled/safeguarded in a gilt fund? A: Debt fund returns result from two reasons: accrual of interest and capital gains. The first component will fall with a decrease in rates over the long term. The second will depend on market supply and demand and is more constant.

Q. If we have a target date to redeem units (ex 20year), will it play a role in fund selection? A: Locking money away for 20Y to escape NAV volatility is a bad idea.

Q: Any correlation between equity and gilt fund volatility? A: Answered above. In principle, yes, In practice, not as often as the uninformed investor demands.

Q. In the long term, the advantage of a gilt fund over a liquid fund (if we assume no credit risk in a liquid fund)? A: A liquid fund return depends only on the accrual of interest. So over the long term, a gilt fund has a reasonable chance of beating a gilt fund. For buy and hold investors, this will not always happen. For those who regularly rebalance (and only they should be buying gilts), the benefit will be better portfolio management with gilts than liquid funds.

Q: If I am looking at a long-term debt element in my portfolio, should I choose – Gilt fund or buy actual gilt papers? A: Unless you need regular income, never buy bonds. The tax will kill returns over the long term.

Q: Glit Vs Money Market? A: The reasoning for liquid funds above is also valid for money market funds.

Q: Relationship between country yield curve and volatility of Gilt/Bonds YTM. At least basic about yield curve will help a lot as it will offer one important way to gauge investors’ inflation expectations for the future. A: This will make a nice article (with little views!), but all it would do is help understand how the economic machine operates in hindsight. In real-time, we will have to speculate, and that does not go right always. It would be better to stick to asset allocation and periodic rebalancing, looking at returns and not macro-economic factors.

Q:1. What to check in SID of MF Scheme to verify whether the Fund has Buy & Hold Strategy or Opportunistic Trading of Bonds Strategy.
2. Does the Number of Securities/AUM matter in the case of Gilt Funds
3. Does Rupee Cost Averaging works with Gilt Funds
A:  1: The next article will cover this in detail.  As regard tactical entry, see: Can we invest via SIP in gilt mutual funds for the long term?
2: It will matter for the volatility but not much in terms of concentration risk or redemption risk.
Q: Can gilt fund be used for portfolio rebalancing with equity funds to achieve desired AA? A: This should be the primary aim of investing in gilt funds.

Q: Do we use the term gilt for only Indian Govt papers? Are there any non- Indian options worth looking at? Also – are there any short duration gilt funds? Mainly like a debt fund with the lowest credit risk possible for the short term ( less than 5yrs). Compared to, say, PPF, which is 15+ years one. Also, can NPS be used as one? Is that a way one can use NPS as a debt fund?

A: Gilts are used for any govt bond. Our rates are among the highest, so it is enough if we stick to India. There are no exclusive short-duration gilts funds. NPS can be used as a gilt fund but only by those for whom it is mandatory or by those who have a stable job with employer contributions going to NPS.

Q: What numbers to look at while picking a gilt fund. For example, maturity, what to see in bonds, how to interpret the bonds in the portfolio. I know there is an old video on this, but I would like a refreshed take. A: A detailed article is coming up.

Q: when it has underperformed FDs and when it beats them(esp for 5+ yrs FDs). A: We do a lot of analysis and come to this conclusion or state it” sometimes gilt funds beat FDs and sometimes not. How things will pan out for us when we start investment is unknown. This is why systematic risk management is crucial for both equity and gilts.

Q: Can the entire debt bucket list can be in a gilt fund? If so, how to rebalance? As both equity and gilt are volatile. A: Very few investors can handle it; their entire debt was in gilt funds. In any case, most of them would have some PPF, EPF kind of instrument at least before retirement. A liquid fund or money market fund can be combined with gilts (where possible) to provide some stability. Rebalancing is a simple, straightforward task as long as the asset allocation is clear.

Q: If someone is a Government employee and contributing to NPS, does it make sense for him to invest in gilt funds?A: Yes, if there is a requirement for it in the portfolio.

Q: How to use gilt funds for a retirement portfolio, and can we use gilt funds for rebalancing the portfolio? A: How do you use PPF or EPF or equity MFs for retirement? The same way (also see next question). As mentioned above, you should rebalance if there is a gilt fund in your portfolio.

Q: Gilt fund vs gilt fund with const maturity 10Y. The differences? and which to choose? Why and what would be impacted as these would be investments for the long term? A: Normal gilts funds are also dynamic bond funds. Typically their volatility would be lower, but they would be subject to fund management risk (the manager can get it wrong about when to buy long-term bonds and when to sell).

The 10Y const maturity is similar to an index fund, but the volatility will be high. This is strictly for those who can stomach the volatility and capitalize from it.

In summary, investors should not get scared from gilt fund volatility, start small via SIP but with a concrete asset allocation plan. Investing in equity alone is not sufficient. One much embrace the volatility not by buying and waiting but by systematic risk management. The same applies to gilt funds. Those who are not ready for this should stay away. Both choices will have consequences.


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