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Gilt vs debt mutual funds: which one scores?


December 16, 2021

A new investment opportunity has opened up for Indian investors, with RBI’s new Retail Direct and other platforms (such as NSE’s goBid and Zerodha Coin) allowing retail investors to directly buy government securities from RBI’s primary auctions. 

Gilt vs debt mutual funds

Our previous article on buying g-secs on the RBI Retail Direct platform outlined how you can go about investing on these platforms. As explained in that article, as a retail investor you can now invest sums ranging from Rs 10,000 to Rs 2 crore in dated central government securities, 91-day, 182-day and 365-day treasury bills, State Development Loans and Sovereign Gold Bonds, whenever RBI conducts auctions of these instruments. 

But many advisors and media outlets have been quick to dismiss g-secs as an investment for ordinary folk, arguing that g-sec investing is complicated and that mutual funds offer a much better alternative, given their friendlier taxation. 

We at PrimeInvestor don’t agree. When evaluating the usefulness of any investment, one needs to consider multiple factors – safety, variety, costs, liquidity – and not just taxation. 

Here we compare the direct g-sec option to the mutual fund route to tell you how and when direct g-secs can add value to your portfolio.

Gilt vs debt mutual funds: the pluses

On doing an honest comparison of the two routes, here are the aspects on which we found direct g-sec investments scoring over MFs.

#1 Higher capital safety

One of the key reasons why investors look at g-secs relative to other fixed income instruments is their sovereign backing which leads to capital safety. Direct investments in g-secs offer better protection against losses than gilts owned through the mutual fund route.  

Here’s why we say this. There are gilt instruments across maturities that a retail investor can invest in, on the RBI Direct platform. In mutual funds, retail investors taking the mutual fund route to gilts can buy dedicated g-sec funds, but these funds are typically for longer-term timeframes and are not short-term. 

Today, there are 28 mutual fund schemes investing only in gilts across the active and passive modes. But these gilt MFs generally take active calls on portfolio duration, that expose you to interest rate risk. We found that 26 of 28 gilt funds today maintain long average maturities ranging from 4 years to 20 years, while only two funds (Franklin India Government Securities and LIC Government Securities) have less than 2-year average maturity. Should interest rates rise, most gilt funds will thus expose you to capital losses or low returns due to falling g-sec prices.  

For short-term periods, there are no dedicated short-term gilt funds. Retail investors can only use debt categories such as liquid, ultra-short, short and low duration funds. These funds primarily use instruments such as corporate commercial paper, bank certificate of deposits, other corporate or bank debt instruments in their portfolios – they devote only some portion of their portfolios to g-secs or T-bills, if at all.   

In these debt categories, you may avoid rate risk but end up taking some credit risk or liquidity risk or even duration risk in categories such as banking & PSU debt, all of which can reduce capital safety. Episodes with liquid and short-term funds in the past and the recent Franklin Templeton saga tell us of the risk potential in these funds if they move down the rating scale or take duration risks. It is true that for the most part, these funds stick to top-rated corporate or bank debt and returns can be higher. But even so, their capital safety is still a few notches below that of treasury bills.

When you buy treasury bills or short-dated g-secs through the direct route, you need have no worries about either rate risk or credit risk. You can simply hold the security till maturity to earn sovereign-guaranteed returns with safe return of your capital.

#2 No mark-to-market

One of the key disclaimers you come across when buying into any mutual fund is that returns are subject to market risk. This applies to funds holding gilts or T-bills too. 

Open-end debt funds allow free entry and exit to investors at the prevailing NAV. This is certainly advantageous for an investor who needs liquidity at short notice. But this very same feature also renders debt fund returns unpredictable for investors who buy them. Every debt fund is required to mark its bond holdings to market every-day. Even relatively stable categories like liquid funds have been brought under a stringent mark-to-market regime in recent times. This means that, irrespective of whether the fund plans to hold a g-sec or T-bill (or any other debt instrument) to maturity, its NAV will be volatile based on daily movements in g-sec or other bond prices and yields. 

The MTM rule leads to uncertainty about the exact return that a debt fund can deliver to its investors, even if their investment horizon broadly matches the fund’s maturity. Investors tend to use a debt fund’s latest Yield to Maturity (YTM) as a rough guide to its likely returns. But the expenses charged by the fund, big inflows or outflows or a change in the portfolio composition can all lead to a deviation in a debt fund’s actual investor returns, relative to its YTM.  

When you directly buy g-secs or T-bills and hold to maturity, you get complete predictability of returns and can completely side-step this MTM risk. On December 8, the RBI auctioned off 91-day, 182-day and 364-day T-bills. The auctions concluded at cutoff yields of 3.48%, 3.81% and 4.12% respectively. Retail investors who were allotted these T-bills at Rs 99.13, Rs 98.13 and Rs 96.04 respectively, can expect these bonds to be redeemed exactly at Rs 100 on maturity date, fixing their effective returns.

#3 No flow worries

With open-end funds, even if you personally follow a disciplined approach and diligently stay the course through ups and downs in the NAV, other investors in the fund can screw up your return experience. MFs pool all kinds of investors into a single portfolio and the presence of other large, jumpy, short-term focused or risk-averse investors in your fund can impact your returns from it. 

For instance, in a fund holding long-dated g-secs, inexperienced investors may rush out when past returns are negative and rush in when past returns are in double digits. This will mean outflows when the rate cycle is peaking and inflows when the rate cycle is bottoming. A sensible investor should be doing exactly the opposite! Such knee-jerk reactions can force the fund manager to sell securities when he should be buying and acquiring securities when he should be staying away. Mistimed inflows and outflows can thus impact returns for staying investors. 

When you buy g-secs through the direct route, your investment actions are under your own control. Your decision to hold to maturity need not be affected by market movements or the ill-considered actions of other investors in the g-sec market.

#4 More maturity options

When choosing debt mutual funds, AMCs often ask you to match your investment horizon to the fund’s maturity profile. SEBI’s categorisation also tells you what debt category you must choose for different investing horizons – liquid funds for horizons of up to 91 days, ultra-short for 3-6 months, low duration funds for 6-12 months, money market funds for up to 1year, short duration funds for 1-3 years and so on. You can also check out a fund’s average maturity or Macaulay Duration to match horizons. 

But given that debt fund managers like to mix and match securities in their portfolios to maximise yields, the Average Maturity or Macaulay Duration of a fund need not accurately reflect the maturities of individual securities in the portfolio. 

 When you match your investment horizon with the fund’s average maturity or Macaulay Duration, it is therefore not a given that you completely avoid rate risks. Yes, target maturity funds solve this problem by fixing their maturity date. But these funds are available only in very limited tenures such as 5 years, 7 years, 10 years and so on right now. For you to make the most of such funds, your investment horizon must fit into these preset maturities.  

In contrast, the g-sec market offers you a far wider choice on maturities. Investing directly in T-bills or g-secs not only allows you to fix your maturity date with certainty but also allows you to choose from a range of tenures. Apart from 91-day, 182-day and 364-day T-bills, RBI auctions 1-year, 3-year, 5-year, 7-year, 10-year, 20-year, 30-year and even 40-year g-secs. 

Not all of these may be available at all times. But then, there are no other MF or FD options in the market that can help you invest in debt instruments with 20, 30 or 40-year tenures, that too with assured rates.  RBI sometimes decides to re-issue older g-secs with in-between tenures too. In such auctions you can get your hands on g-secs with odd residual maturity such as 2 years, 4 years or 6 years. The availability of RBI’s auction calendar in advance helps you participate in auctions with specific tenures to match your horizon.

#5 Cost advantage

When you own g-secs via mutual funds, even through direct plans, the returns you earn are net of the funds’ Total Expense Ratio. Gilt ETFs can be subject to both TER and transaction costs charged by the exchanges. The costs associated with participating in direct retail g-sec platforms are much lower. Brokers such as Zerodha Coin charge an ultra-low 0.06% as brokerage when you invest in g-secs. RBI’s Retail Direct Platform comes completely free and doesn’t charge you any account opening, maintenance or transaction fee for buying g-secs in primary auctions.

Gilt vs debt mutual funds: the minuses

#1 Unfriendly taxation

One of the biggest disadvantages of buying g-secs directly rather than taking the MF route is that you’d lose out on the friendly taxation of debt mutual funds. Current tax rules allow you to convert the interest income that you earn on your debt fund portfolio into capital gains to benefit from lower rates of tax. 

When you invest in a growth option of a debt fund and hold on for 3 years, all your NAV returns from the fund (which will include interest receipts and capital gains) get taxed at 20% after applying indexation benefits. This makes only your real returns from debt funds subject to tax and really lowers your tax outgo, bolstering post tax returns. When you directly buy g-secs though, your interest income is added to your income in the very same year and taxed at your slab rate. For tenures beyond 3 years, you don’t get indexation benefits which can significantly boost your post-tax returns in debt MFs. 

However, the tax argument does not apply when you plan to invest in g-secs for less than 3 years or for the extremely long-term like 20, 30 or 40 years (because comparable MF options are not available).

#2 No compounding benefits

When you invest in the growth option of debt funds, the interest accruals on the portfolio automatically get reinvested at prevailing rates, giving you compounding benefits in the long run. With g-secs which pay out half yearly interest, there is no cumulative option or compounding benefit. Unless you reinvest the interest, this means missing out on substantial compounding benefits in the long run.

#3 Uncertain liquidity

As we explained in our earlier article on the RBI Retail Direct platform, India’s secondary market for bonds lacks depth even if you’re only dabbling in g-secs. Given that retail investors are restricted to the Odd Lots segment and that very few g-secs (like the most recent 10 year and 5 year) get traded each day, any exit from the g-secs you buy in primary options may not be practical. MFs in contrast offer you the facility of anytime exit at NAV.

#4 No help with selection

While most Indian investors are quite familiar with equities, they’re not well acquainted with how bond markets work. The inverse relationship between interest rates and bond prices and the heavy dose of jargon about cutoff yields, yield curves, term premiums, spreads et al may make g-sec selection seem very complicated to first-time investors. 

But then, any new asset class is puzzling at first and learning about the g-sec market is an investment that is well worth it. After all, how difficult can it be to choose sovereign backed bonds that pay out an assured return? There’s not much room to go wrong with g-secs if you hold till maturity! 

Directly investing in g-secs, therefore, are especially useful if you prioritize capital safety and certainty or predictability of returns over higher returns. Gilt mutual funds may well deliver higher returns than the yield of a single g-sec – but this comes from active management of duration, which leads to volatility and is rather hard to take for many investors. You don’t need to dedicate your entire portfolio to g-secs, too! You can always include these as part of your debt investments, to balance against the risks you’re taking in your debt funds.

G-secs also come especially in handy for Investors who want to set up monthly income streams, such as retirees, as they offer a great combination of capital safety, long maturities with reasonable coupons. 

Of course, as pointed out, the challenge is in selection. But when you have us, there’s a solution! With the g-sec market now more accessible, we’re working on building g-sec recommendations, for regular retail investors and retirees based on opportunities. We’ll let you know!

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Although the client may notify to us his/her intention to his/her subscription, such notice will only take effect at the end of his/her then current subscription period, and he/she will not receive a refund other than as set out under Clause 8 in these Terms.

The client may notify us of his/her wish to cancel his/her subscription by sending an email to [email protected]. The client must provide at least 5 business days advance notice for this to be implemented.

Refunds: There can be no cancellation and refund of subscription fee paid once the subscription is active, other than as stated in Clause 8 of these Terms. If the client is entitled to a refund as specified under Clause 8 of these Terms, the RA will credit that refund to the card or other payment method used by the client to submit payment, unless it has expired - in which case the RA will contact the client to proceed with the refund. If we do issue a refund or credit due to circumstances outside the obligations specified under Clause 8, we are under no obligation to issue the same or a similar refund in the future.

General disclaimers: The recommendations made herein in the Research Services are expression of views and/or opinions and should not be deemed or construed to be advice for the purpose of purchase or sale of any security, nor a solicitation or offering on any investment/ trading opportunity on behalf of the company, AMC, insurance company, or issuer of security referred to herein.

The content and research reports generated by the RA does not constitute or is not intended to constitute an offer to buy or sell, or a solicitation to an offer to buy or sell financial products, units or securities.

The information/ opinion/ views mentioned in research reports or by the RA are not meant to serve as a professional guide to the client or recipients of this Report. The research report, recommendation, or any other content published by the RA do not assure or guarantee any minimum or fixed returns to the client or recipients of the reports/ recommendations/ content.

Use of this information is at the client’s own risk. The client must make his/ her own investment decisions based on his/her specific investment objective and financial position and using such independent advisors as he/she believes necessary. The services rendered by the RA are on a best-effort basis. All information in the content or research report of the RA is provided on an as is basis. Information is believed to be reliable but the RA does not warrant its completeness or accuracy and expressly disclaim all warranties and conditions of any kind, whether express or implied.

While due care has been taken to ensure that the disclosures, information, and opinions given are fair and reasonable, PrimeInvestor Financial Research Pvt Ltd and/or none of its officers, directors, partners, employees, agents, subsidiaries, affiliates or business associates shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way whatsoever from the information/ opinions/ views contained in the research report and recommendations that form part of the Research Service, and/or mails, social media or notifications issued by PrimeInvestor Financial Research Pvt Ltd or any other agency appointed/authorised by PrimeInvestor Financial Research Pvt Ltd. Returns and performance figures mentioned in the research report represent past performance and should not be constituted to be future returns or guaranteed returns.

Any agreements, transactions or other arrangements made between the client and any third party named on (or linked to from) the Website are at your own responsibility and entered into at your own risk. Any information that you receive via the Website, whether or not it is classified as “real time”, may have stopped being current by the time it reaches you. Market price information may be rounded up/down and therefore may not be entirely accurate.

The purpose of these disclosures is to provide essential information about the Research Services in a manner to assist and enable the prospective client/client in making an informed decision for engaging in Research Services before onboarding.

History, present business and background: PrimeInvestor Financial Research Private Limited is registered with SEBI as Research Analyst with registration no. INH200008653. The Research Analyst got its registration on August 19, 2021 and is engaged in offering research and recommendation services.

Disciplinary history: There are no pending material litigations or legal proceedings against the Research Analyst. As on date, no penalties / directions have been issued by SEBI under the SEBI Act or Regulations made thereunder against the Research Analyst relating to Research Analyst services.

Details of the RA's associates: No associates.

Usage of Website Content: This Website is controlled and operated by the RA. All material, including research reports, recommendations, portfolios, ratings, lists of financial products, illustrations, statements, opinions, views, photographs, products, images, artwork, designs, text, graphics, logos, button icons, images, audio and video clips and software (collectively, “Content”) are protected by copyrights, trademarks and other intellectual property rights that are owned and controlled by the RA or by other parties that have licensed their material to us.

Except where otherwise agreed in writing with the RA, material on the Website is solely for the client’s personal, non-commercial use. Except as provided below, the client must not copy, reproduce, republish, upload, post, transmit or distribute such material in any way, including by e-mail or other electronic means and whether directly or indirectly and the client must not assist any other person to do so.

Without the prior written consent of the RA, modification of the materials, use of the materials on any other web site or networked computer environment or use of the materials for any purpose other than personal, non-commercial use is a violation of the copyrights, trademarks and other proprietary rights, and is prohibited. Any use for which the client receives any remuneration, whether in money or otherwise, is a commercial use for the purposes of these Terms.

The client may occasionally distribute a copy of a research report, or a portion of the same, from the Website in non-electronic form to a few individuals without charge, provided the client includes all copyright and other proprietary rights notices in the same form in which the notices appear, original source attribution, and the phrase “Used with permission from PrimeInvestor Financial Research Pvt. Ltd.”

While the client may occasionally download and store research reports or information from the Website for his/her personal use, he/she may not otherwise provide others with access to the same. The foregoing does not apply to any sharing functionality we provide through the Website that expressly allows the client to share Content or links to Content with others. In addition, the client may not use Content he/she has downloaded for personal use to develop or operate an automated trading system or for data or text mining.

The client agrees not to rearrange or modify the Content available through the Website. The client agrees not to display, post, frame, or scrape the Content for use on another website, app, blog, product or service, except as otherwise expressly permitted by these Terms. You agree not to create any derivative work based on or containing the research products and Content. The framing or scraping of or in-line linking to the Services or any Content contained thereon and/or the use of webcrawler, spidering or other automated means to access, copy, index, process and/or store any Content made available on or through the Services other than as expressly authorized by us is prohibited.

The client further agrees to abide by exclusionary protocols (e.g., Robots.txt, Automated Content Access Protocol (ACAP), etc.) that may be used in connection with the Research Services. The client may not access parts of the Research Services to which he/she is not authorized, or attempt to circumvent any restrictions imposed on your use or access of the Services.

As a general rule, the client may not use the Content, including without limitation, any Content made available through one of our RSS Feeds, in any commercial product or service, without our express written consent.

The client may not create apps, extensions, or other products and services that use our Content without our permission. The client may not aggregate or otherwise use our Content in a manner that could reasonably serve as a substitute for a subscription to the Website.

The client may not access or view the Services with the use of any scripts, extensions, or programs that alter the way the Services are displayed, rendered, or transmitted to you without our written consent.

The client agrees not to use the Services for any unlawful purpose. We reserve the right to terminate or restrict the client's access to the Website if, in our opinion, the client's use of the Services may violate any laws, regulations or rulings, infringe upon another person's rights or violate these Terms.

Prohibited content: The Website includes comments sections, blogs and other interactive features that allow interaction among clients and between clients and the RA. We call the information posted by or contributed by users “Contributed Content.” In the course of availing of the Research Services or uploading any post or comment on the Website, the client shall not post any Contributed Content that (i) contains nude, semi-nude, sexually suggestive photos, (ii) tends or is likely to abuse, harass, threaten, impersonate or intimidate other users of the Website and/or Research Services, (iii) is lascivious or appeals to the prurient interest or if its effect is such as to tend to deprave and corrupt persons who are likely to use or have access to the Website and/or Services, or (iv) otherwise violates, is prohibited or restricted by applicable law, rule or regulation, is offensive or illegal or violates the rights of, harms or threatens the safety of other users of the Website and/or Services (collectively “Prohibited Content”).

We reserve the right to cease to provide the client with the Research Services or access to the Website, or terminate your subscription, with immediate effect and without notice and liability, for violating these Terms, applicable law, rules or regulations and reserves the right to remove Prohibited Content which is in violation of these Terms, or is otherwise abusive, illegal or disruptive. The determination of whether any content constitutes Prohibited Content, violates these Terms, or is otherwise abusive illegal or disruptive, is subject to the sole determination of the Firm.

Changes to Research Services: We are constantly endeavouring to improve the quality of Research Services provided to our clients. Due to this, the form and nature of the Research Services provided may change from time to time without any prior notice to the client. We reserve the right to introduce and initiate new features, functionalities, components to the Website and/or Research Services and/or change, alter, modify, or discontinue existing ones without any prior notice to the client.

Warranty and liability disclaimer: The Website, Research Services, and all the materials and services, included on or otherwise made available to the client through this Website is provided by the RA on an “as is” and “as available” basis without any representation or warranties, express or implied except otherwise specified in writing. Without prejudice to the foregoing paragraph, the RA does not warrant that:

  • This Website and/or Research Services will be constantly available, or available at all;
  • The information on this Website or provided through the Research Services is complete, true, accurate or not misleading; or
  • The quality of any products, services, information, or other material that you obtain through the Website or Services will meet your expectations.

The RA, to the fullest extent permitted by law, disclaims all warranties, whether express or implied, including the warranty of merchantability, fitness for particular purpose and non-infringement. The RA makes no warranties about the accuracy, reliability, completeness, or timeliness of the Website, Research Services, Content, Contributed Content, Services, software, text, graphics and links.

The RA does not warrant that this Website, Research Services, information, content, materials, or any other material included on or otherwise made available to you through this Website, their servers, or electronic communication sent by the RA are free of viruses or other harmful components.

Nothing on this Website constitutes, or is meant to constitute, advice of any kind.

Indemnification: The client:

  1. Represents, warrants and covenants that no materials of any kind provided by him/her will:
    1. Violate, plagiarise, or infringe upon the rights of any third party, including copyright, trademark, privacy or other personal or proprietary rights; or
    2. Contain libellous, Prohibited Content or other unlawful material;
  2. Hereby agree to indemnify, defend and hold harmless the RA and all of the RA’s officers, directors, owners, agents, customers/clients, information providers, affiliates, licensors and licensees (collectively, the “Indemnified Parties”) from and against any and all liability and costs, including, without limitation, reasonable advocate’s fees, incurred by the Indemnified Parties in connection with any claim arising out of any breach by the client of these Terms or the foregoing representations, warranties and covenants. The client shall cooperate as fully as reasonably required in the defence of any such claim. The RA reserves the right, at its own expense, to assume the exclusive defence and control of any matter subject to indemnification by the client.

Applicable law: This Website, including the Content and Contributed Content and information contained herein, and the provision of Research Services shall be governed by the Securities and Exchange Board of India, laws of the Republic of India and the courts of Chennai, India which shall retain exclusive jurisdiction to entertain any proceedings in relation to any disputes arising out of the same. As such, the laws of India shall govern any transaction completed using this Website.

Information gathered and tracked: Information submitted or collected on the Website or pursuant to the use of the Services is stored in a database. Specifically, we store the username, name, e-mail address, contact number, as submitted or collected on our Website or through the provision of the Research Services. We may use such information to send out occasional promotional materials, including alerts on new Services available, or other promotional and marketing material relating to our clients and customers.

In accordance with the Information Technology Act 2000, the name and the details of the Grievance Officer at PrimeInvestor is provided below:

Mr. Srikanth Meenakshi
PrimeInvestor Financial Research Pvt. Ltd., Registered office: 659, 4th Avenue, D-Sector, Anna Nagar Western Extension, Chennai 600 101.
Email: [email protected]

11. Mandatory notice:

Clients shall be requested to go through Do’s and Don’ts while dealing with RA as specified in SEBI master circular no. SEBI/HO/MIRSD-POD-1/P/CIR/2024/49 dated May 21, 2024 or as may be specified by SEBI from time to time.

12. Optional Centralised Fee Collection Mechanism:

SEBI has operationalized a centralized fee collection mechanism for IA and RA. Under this mechanism, clients shall pay fees to IAs/RAs through a designated platform/portal administered by a recognized Administration and Supervision body. This is an optional mechanism for the registered entities. At this time, PrimeInvestor has opted out of this fee collection mechanism. Therefore, all subscription payments for the Research Services will be through the modes as specified in Clause 5 of these Terms.

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