Gilt fund returns soar as yields soften

Spectacular run started after September; some schemes have returned as much as 19% in the past year

Gilt funds, mutual fund schemes investing in government securities (g-secs), have had a good run in the past year. Schemes in this category have returned as much as 19 per cent in the past year, amid softening of yields on expectation of easing in interest rates.

The Reserve Bank of India (RBI)’s announcement last week of a 25 basis points cut in repo rate has sweetened the deal further.

Gilt funds have had a spectacular run after September, when the macro-economic data showed significant improvement, raising hopes of a rate cut by RBI.

“The performance of these funds till about July last year was not that great. But as the expectation built in that all data points have started hinting at a softening interest rate cycle, yields started coming down,” said Killol Pandya, senior fund manager - fixed income, LIC Nomura Asset Management.

Gilt funds predominately invest in 10-year benchmark government bonds, 91-day and 180-day treasury bills.

A rise in interest rates push up yields, while a fall would bring these down. Drop in yields results in capital gains for investors, as yields and prices move in opposite directions.

Inflation data has been on a decline since July last year after it touched a five-month high of 7.23 per cent. As of November 2014, inflation data stands at 4.12 per cent. The industrial production data has also been on a downtrend signalling slow pick-up in the manufacturing sector. “It was clear that the interest-rate cycle had peaked and a rate-cut is imminent,” said Pandya.

Meanwhile, commodity prices worldwide started falling, led by the decline in crude prices from over $115 a barrel to nearly $50 a barrel after June last year.

Metal prices fell on slowing Chinese growth rate, the world’s largest consumer of these. These further pushed inflation down.

Going forward, debt funds investing in government securities, as well as other duration funds with smaller exposure to government funds like income or bond funds or short-term and ultra short-term funds, are expected to do well.

“We are at the start of the interest rate cycle and are expecting at least another 50-100 basis points rate cut. It is still not late for investors who have missed the recent rally,” said Akhil Mittal, senior fund manager –fixed income, Tata Asset Management.

Experts expect at least two-three tranches of rate cuts later in the year. Yields have already started factoring in the next rate cut and have gone down to 7.75 per cent after the rate cut announcement.

Yields could come down to 7.50 per cent, they said, which drive returns of gilt funds. “Last year, we had both asset classes, debt and equity, doing well in the second half of the year. Investors rarely have such a choice,” said Dwijendra Srivastava, head of fixed income at Sundaram Mutual.

Between July and December 2014, assets under gilt funds rose by about 60 per cent to Rs 9,045 crore, as opposed to a 23 per cent decline in assets in the previous six months.