Will RBI’s New Scheme for Retailers Affect Gilt Funds?

Are you looking at fixed-income investments to strengthen your portfolio? Do you want to invest in government bonds for the long term? You may consider investing in gilt funds. It is a debt fund that invests mainly in government securities. However, the RBI recently unveiled an ‘RBI Retail Direct’ scheme where retail investors can invest directly in government bonds. Will RBI’s new scheme for retail investors affect gilt funds?

What are gilt funds?

You have gilt funds as a type of debt fund that invests a minimum of 80% of their assets in government securities. Moreover, you have two types of gilt funds. For instance, gilt funds invest predominantly in government securities across maturities and those with a constant maturity of 10 years. 

You have gilt funds investing in government securities that have zero default risk. However, they are impacted by interest rate fluctuations in the economy as their portfolio has government bonds of a longer duration. 

Should you invest in gilt funds?

You may invest in gilt funds if you are a savvy investor who understands the bond market. It helps as these funds invest in government bonds of a longer duration and are affected by interest rate movements. You may consider gilt funds if you have an investment horizon of three to five years. 

You will have to time your entry and exit in gilt funds to realise a higher return. Moreover, you must invest in these funds when interest rates are falling. For example, the demand for government securities issued earlier rises when the RBI cuts interest rates in the economy as they have a higher interest rate. The price of these securities rises when the demand goes up even as bond yields fall.

You have an inverse relationship between the price of bonds and their yield. For instance, if the RBI cuts interest rates in the economy, the price of government bonds of a longer duration will rise. As gilt funds invest predominantly in these bonds, their NAV also goes up. 

However, if the RBI increases the interest rates in the economy, the price of government bonds of a longer duration will fall. You will find the NAV of gilt funds falling in a rising interest rate scenario. 

What is the Retail Direct Gilt Account?

You have the RBI issuing a scheme where retail investors can purchase and sell government securities. It helps you invest in sovereign gold bonds, state development loans, treasury bills and Government of India dated securities through the Retail Direct Gilt Account. 

You may invest in this scheme if you are a resident individual with a savings bank account or an NRI who complies with the Foreign Exchange Management Act, 1999. Moreover, you can invest in the Retail Direct Gilt Account through an online portal only after completing your KYC (Know Your Customer) documentation. 

Retail investors can invest in government securities in primary and secondary government bond markets through this scheme. Earlier, only institutional investors such as foreign portfolio investors, high net worth individuals, insurance companies and mutual funds could invest in government securities. Now, even retail investors can trade in government securities with a minimum investment of only Rs 10,000. 

Will RBI’s new scheme for retailers affect gilt funds?

You can invest directly in government securities through RBI’s Retail Direct Gilt Account only if you understand these investments. Moreover, it would help if you held these securities until maturity to avoid capital losses. 

If you sell these government securities before maturity in the secondary market, the returns depend on the interest rate trends in the economy. Moreover, adverse movements in interest rates could result in losses when trading government securities in the secondary market. 

You may consider investing in gilt funds instead of directly investing in government securities if you are a novice investor in bonds. It helps as the fund manager and the research team buy and sell government securities to maximise returns based on the interest rate movements. Moreover, as many investors in India are first-timers in the bond market, the new scheme won’t significantly impact gilt funds. 

You must invest in gilt funds only if you can time your entry and exit in these schemes. Moreover, it helps if you understand the impact of interest rate fluctuations on your investment. Gilt funds have an average portfolio maturity ranging from three to five years. In a nutshell, you must invest in gilt funds only if you understand bond markets and have a longer time horizon to achieve your financial goals. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in