The early 19th Century saw the Government borrow money through the issuance of a physical document, known as a bond. Bearing the terms of this borrowing and signed off by both parties, these bonds were adorned with Gold lace around the edges as an indication of their importance. Hence, they earned themselves another name – Gilt-edged bonds.
At the end of the day, Gold does not eradicate credit or interest rate risk – this is, in essence, still a bond.
The Government’s status as the borrower implies that Credit risk is virtually eliminated – it is simply not possible for them to default on debt obligations.
The legacy of GILT remains, though nowadays the gold lacing is no longer present. Instead, these bonds still hold a Sovereign Guarantee firmly in place.
A mutual fund that primarily invests in Government bonds or Gilts is referred to as a ‘Gilt Fund’.
Here is SEBI’s definition of a GILT fund –
There are two types of GILT funds –
Gilt with ten-year constant duration has a fixed duration of ten years which alters its risk profile entirely. As compared to the fund discussed previously, this one is subject to Macaulay’s duration being no less than ten years.
It is clear that the investor does not have to worry about Credit risk here. However, the Interest rate risk in these funds, especially the constant duration one, should be taken into account. The magnitude of this risk might be large enough to offset the lack of Credit risk.
I would earnestly suggest that you examine the fact sheet of any GILT fund’s duration and modified duration, to get an understanding of its riskiness.
If you’re thinking of investing in these funds, do it with a long-term outlook – we’re talking 8-10 years here.
I don’t believe that a GILT fund has any place in the average retail investor’s portfolio; it would be better to leave it out altogether.
We have now concluded our review of debt funds. For our next topic, we will be covering ETFs and Index funds.