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Wednesday, November 26, 2014

A re-look at Gilt funds – a guest post

Both WPI and CPI inflation rates have been moving down. However, there are questions whether inflation is low because of a higher base effect. As the base effect wears off from Jan ‘15 onwards, inflation may rise again.

Industrial growth continues to be tepid. India Inc. have been clamouring for an interest rate cut to spur growth. The RBI Governor has so far left rates unchanged till inflation gets firmly under control.

If inflation stays low during Jan-Feb ‘15, then a 25 or 50 bps rate cut in Feb ‘15 is a possibility. That should provide impetus to the stock market and gilt fund returns. In this month’s guest post, Nishit suggests a re-look at gilt funds as a safe diversification avenue for your investments.

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The 10 year Government Security yield has come down to 8.15% from a peak of about 9.10% in April. So, should one invest in Gilt funds now?

Gilt funds offer an interesting diversification from equity and Gold investments. They work best when interest rates are coming down and bond prices go up. For example, if a Rs 100 bond is yielding 9% interest and if the interest rate comes down to 8%, then the same Rs 100 bond will cost Rs 112.50 to yield 8% interest.

So, one stands to make a return of say about 12-13% if the interest rate comes down by 1% in about 6 months.

Inflation is going down and so are fuel prices. An interest rate cut by RBI is expected - if not in December ’14 then definitely in February ‘15.

The Government prefers low interest rates as industry can borrow at lower rates and make more investments leading to more employment and growth in the economy. The Finance Minister has already tried nudging the RBI Governor to reduce interest rates. The fear of inflation re-emerging is what is holding back the RBI from reducing interest rates in a hurry.

Interest rate is expected to come down to 7.75% in the next 4-6 months. Currently it is at 8%.

For those who have already invested in Gilt funds, now is the time to enjoy the profits. Those with a horizon of 6 months also can look at Gilt funds as a measure of diversification. Over the last 3 years, gilt funds have given an annual return of about 10%.

In a complete cycle of top to bottom when the interest rates start falling, they typically give about 25% returns out of which 10-12% have been realised already.

Interest rates usually bottom around 7%. Gilt funds can be used to optimise returns from fixed income instruments and one can invest about 5-10% of total allocated funds for investment.

The risk to Gilt funds arises from interest rates going up and at such times, the funds give very low returns.  For those who want to play the interest rate cycle, gilt funds offer the perfect medium.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan. You can reach him at nish.stockid@gmail.com)

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