Gilt funds are debt-oriented funds that mainly invest in government bonds. They include securities issued by the Central and State Governments. When the government needs to borrow money, it issues these bonds to raise funds. A gilt scheme buys these bonds on investors’ behalf.

As per SEBI’s current categorisation, a gilt fund must invest at least 80% of its total funds in government securities. This makes them different from other debt schemes, such as corporate bond funds and credit risk funds, that lend mainly to companies.

Although ideally gilt funds are low-risk debt funds, they still carry interest-rate risk. When market interest rates rise, existing government bonds can lose value.

Gilt funds may suit you if:

• If you want government securities in your debt portfolio: If you don’t want to take corporate credit risk, then gilt funds give you exposure to government bonds through a mutual fund.
• If you can stay invested for several years: Gilt funds can see meaningful NAV movements when interest rates change. A longer investment horizon can make it easier to handle these short-term ups and downs.
• If you understand interest rate cycles: When the RBI cuts interest rates, the prices of government securities may rise. If you understand this relationship and the market interest rate environment, then you can consider gilt funds.
• If you want to diversify your equity portfolio: If you already invest in equity schemes such as multi-cap funds or flexi-cap funds, this scheme can give you a separate debt allocation to balance your risk profile.

Once you invest in gilt funds via SIP or lump sum, the fund manager uses that money to buy government securities with different maturities. These securities could be central or state government bonds issued by the Reserve Bank of India.

The fund then earns returns from these investments in two main ways:

• Coupon income: Government bonds pay interest, known as coupon payments. This income contributes to the fund’s returns.
• Changes in bond prices: Since government securities trade publicly, their market value rises and falls. Normally, when interest rates reduce, existing bonds become more valuable as they may carry higher coupon rates than newly issued bonds.

This can increase the fund’s NAV. However, the reverse can happen when interest rates rise.

To better understand, let’s consider a scenario. Suppose you invest ₹10,000 in a gilt fund when its NAV is ₹20. You receive 500 units (₹10,000/₹20). Now, let’s say the RBI cuts interest rates, and bond prices rise. The fund's NAV can rise. Let’s say it goes to ₹21. Your 500 units would be worth ₹10,500 (500 units x ₹21).

The ₹500 increase comes from the change in the value of the fund’s portfolio. The actual return of a gilt fund will depend on interest income, expenses and other factors.

There are two categories of gilt funds you should know:

• A regular gilt fund: The standard gilt fund has the flexibility to hold government bonds with varied maturities. The fund manager can change the portfolio’s duration depending on the fund’s strategy and market conditions. This gives the fund manager more flexibility in deciding how much interest-rate risk the fund takes.
• Gilt fund with 10-year constant duration: A 10-year gilt fund has a more specific mandate. It must invest at least 80% in G-Secs, with the portfolio’s Macaulay duration maintained at 10 years. Since the duration stays around 10 years, these funds can be quite sensitive to changes in interest rates.

Here’s a quick look at the differences between the two:

Gilt funds offer the following benefits:

• Very low credit risk: Since the portfolio is focused on government securities, the fund does not depend on the issuer’s financial health, unlike bonds of private companies.
• Benefit from falling interest rates: When bond prices rise as interest rates fall, these schemes benefit from capital gains in addition to coupon income.
• Diversification of portfolio: Gilt funds can add government bond exposure alongside equity investments such as Nifty 50 funds, Sensex funds, flexi-cap funds or focused funds.
• No fixed maturity: These funds are open-ended schemes. So you don't have to wait for one particular bond to mature before redeeming your units. You still need to check the applicable exit-load and redemption rules for the specific scheme.
• Different options for different duration needs: You can choose between a regular gilt fund and a 10-year gilt fund depending on the kind of government bond exposure you want.

While considering gilt funds to invest in, you must consider these risks:

• High interest-rate risk: Changes in interest rates can have a bigger impact when the fund holds longer-duration securities. Any sudden rise or fall in the rate can make the fund volatile.
• Not suitable for very short-term money: If you need the money in a few weeks or months, a gilt fund may expose you to unnecessary interest-rate movements. Overnight funds, liquid funds or ultra-short duration funds may be better options for shorter-term needs.
• Possibility of short-term losses: A gilt fund can give negative returns over a short period, even though its underlying securities are government bonds.

Here’s how gilt funds compare with a couple of other debt mutual fund schemes:

If you want government-backed debt but don’t want the same level of duration exposure, you can consider short-duration funds, medium-duration funds or banking and PSU funds.

If you’re comparing the best gilt mutual funds, don’t look only at past returns. A fund can post strong returns simply because it benefited from a favourable interest-rate cycle. Instead, check:

• Portfolio duration: Longer duration usually means greater sensitivity to interest-rate changes.
• Fund strategy: See whether the manager actively changes duration or follows a more specific duration mandate.
• Expense ratio: Lower costs can help reduce the amount of your return lost to expenses. For better net returns, prefer direct plans over regular ones.
• Past performance across rate cycles: Don’t judge a gilt fund using only its latest one year return. Check how it has performed during different interest rate environments.

Make sure the fund’s duration and risk level match the period for which you can stay invested.

Once you’ve decided to invest in gilt funds, starting your SIP on Millions takes just a few quick steps:

• Download the Millions app and complete your KYC to set up a free account.
• Go to the mutual funds section, search for gilt funds and compare the curated options based on duration and performance history.
• Select your preferred scheme and tap SIP to choose the frequency from daily, weekly, or monthly.
• Enter your investment amount, pick your recurring debit date, and authorise the initial payment.

Your gilt fund SIP is officially live! When it comes to investing in gilt schemes, consistency and long-term investing are more beneficial. However, if you need money in a shorter duration, you can explore options like liquid funds or overnight funds. For longer-term wealth generation, you can consider equity-oriented schemes like small-cap funds, mid-cap funds, or more stable options like Nifty 50 funds or Sensex funds.