Safety guaranteed: Diversify into g-secs to lower risk in your portfolio

Choose instrument by matching your investment horizon with tenure of the paper

The Reserve Bank of India (RBI) has introduced a mobile app for its Retail Direct Gilt (RDG) scheme, which enables retail investors to invest in the primary and the secondary market for sovereign bonds. This is a follow-up of its November 2021 initiative when it had made government securities (G-Secs) available to retail investors by launching the Retail Direct portal (rbiretaildirect.org.in).

The launch of a mobile app is expected to improve retail investors’ access. “It will make investing in G-Secs simpler and more convenient,” says Vijay Kuppa, chief executive officer (CEO), InCred Money.

Zero credit risk

G-Secs are sovereign-guaranteed instruments, which means they carry zero default risk. They can also help investors diversify their portfolios. “If you hold equity and gold, you can add G-Secs on the fixed-income side as the risk-free allocation,” says Kuppa.

G-Secs (and treasury bills) have tenures ranging from 91 days to 50 years. “Investors can choose a paper based on their investment horizon,” says Joydeep Sen, corporate trainer (debt markets) and author.

The returns are safe and predictable. “These instruments offer half-yearly interest payouts. Safety of capital is also assured,” says Udbhav Shah, founder, Dravyasiddhi.

 

With interest rates at or near the peak of this cycle, experts say G-Secs are offering decent yield to maturity (YTM) currently.

While the gap between the returns from fixed deposits (FDs) of tier-1 banks and G-Secs has shrunk, in some parts of the interest-rate cycle the latter offer better returns. “Since G-Secs are market-linked instruments, they respond immediately to rising rates within the economy while banks hike their deposit rates with a lag,” says Shah.

In gilt mutual funds (MFs), investors have to pay an expense ratio. “There is no cost, such as a brokerage or a management fee, in G-Secs purchased through the RBI RDG account,” says Sen.

As time passes, the residual maturity of a G-Sec falls. “This is not the case in a gilt MF where the average maturity depends on the fund manager’s view on interest rates. The reducing residual maturity of a G-Sec means its volatility declines with time,” says Sen.

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Beware interest, liquidity risk  

Interest-rate risk: Bond prices and yields have an inverse correlation. “If interest rates have moved up and you decide to sell a G-Sec before maturity, you would suffer losses,” says Sen.

Many G-Secs have longer maturities going up to 50 years. “Prices fluctuate more in longer-duration papers in response to interest-rate changes,” says Kuppa. Investors can eliminate this risk by holding G-Secs till maturity.                      

Liquidity risk: Retail investors can invest in minimum lot size of Rs 10,000. “If a retail investor wants to sell G-Secs, there has to be a buyer for that particular paper and that particular quantity on that day. There is no guarantee that liquidity will be available,” says Sen. Those who wish to cash out immediately may have to take a haircut. “Investors willing to wait for some time usually manage to sell their holdings without a haircut,” says Kuppa.

There is greater liquidity in the secondary market for wholesale or institutional transactions where lot sizes are bigger (typically Rs 2, 5, 10 or 50 lakh and Rs 1 and 5 crore).

Retail investors also face liquidity issues when trying to sell odd lots. “G-Secs worth, say, Rs 3 lakh, would be treated as an odd lot because institutional players buy and sell in multiples of Rs 2 lakh or Rs 5 lakh. You might get a lower price for such bonds,” says Shah. He adds that liquidity has improved over the past couple of years, with the entry of online bond broking platforms, which also offer G-Secs.

Reinvestment risk: This is the risk that if your G-Sec holdings mature when interest rates within the economy are low, you would be forced to reinvest at lower rates. While G-Secs are safe, that safety comes with lower returns compared to corporate bonds.

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Tackling risks

To tackle duration risk, go for a lower-duration paper so that volatility is minimised. But the downside is that if at the end of this period interest rates are low, you would have to reinvest at those rates.

To tackle reinvestment risk, lock into longer-duration papers. With interest rates currently at elevated levels, you will be able to enjoy these rates for a longer period. But longer-duration papers are more volatile.

“The bottomline is that you can minimise one of these risks, not both, at the same time,” says Kuppa.

Investors may also ladder their investments across tenures so that all the bonds they hold do not mature at the same time. To counter the problem of G-Secs offering lower returns than corporate bonds, build a diversified fixed-income portfolio with some allocation to both.

Shorter-tenure gilts attractive    

Some allocation to G-Secs can be done in most fixed-income portfolios. “Investing in them will lower the overall credit risk of your portfolio,” says Kuppa. Shorter tenure G-Secs are attractive at present. “The yield curve is very flat today, so shorter-tenure papers are more attractive. They are not as volatile as longer-duration papers while offering similar yields,” says Sen.

While investing, compare G-Sec returns with those offered by tier-1 banks and small savings instruments. Go for G-Secs if they are offering a higher yield. For longer tenures, G-Secs become the default option as banks do not offer FDs of more than 10 years. Sen suggests selecting the tenure of a G-Sec by matching it with one’s investment horizon.

Investors not sure of their investment horizon could face liquidity and reinvestment risk at the time of exit. “Such investors may go for G-Sec MFs, where the fund house is bound to honour your redemption request at net asset value,” says Sen.

Those who want regular cash flows during retirement may go for very long-tenure G-Secs (after comparing their returns with those of immediate annuities). “If you believe India will gradually move towards a lower interest-rate regime, you could lock into 40- or 50-year G-Secs,” says Shah. He adds that after your lifetime, these instruments can be passed on to your children who can enjoy the higher rates (assuming rates prevailing then are lower).