Government bond yields have been falling and are expected to fall further. In the last one year, the benchmark 10-year yield has slipped from 8.60% to 7.60%, or 100 basis points (bps).
If you had invested at 8.60% you are now looking at a return of 15% on an instrument carrying no credit risk and very low liquidity risk.
Even equities have not given such returns, nor have any high-yield corporate bonds that carry both high credit as well as high liquidity risk.
The outlook for government bonds is positive and 10-year yields are expected to fall further by 60 bps to levels of 7% by the end of this fiscal. If you invest in one now, you can expect a return of 11.6% over the next one year if the government bond yield falls to 7%.
Well, 11.6% on a risk-free, liquid security is extremely good in the current economic environment where there is stress on corporate assets due to a weakening economy and there are scams galore.
But it’s not easy for individuals to invest directly. The market lot size is Rs 5 crore and you would have to approach a primary dealer or a bank or invest in a debt PMS (Portfolio Management Scheme) that’ll buy government bonds. Government bonds carry semi-annual coupon (interest payment) and you will have to pay full tax it.
The best vehicle for investment in government bonds are gilt funds. They carry no credit risk and very low liquidity risk, as the underlying assets are government securities. Holding a gilt fund for more than a year makes you liable to pay only long-term capital gains tax. Gilt funds also carry low expense ratios and do not usually have exit loads. In a falling interest rate environment, gilt funds offer you the best risk return profile.
The risk in government securities is the risk of interest rates moving up. If interest rates move up, you are liable to suffer capital loss in the short term, if you do sell the bond. However, in the long term, even if interest rates move up, you would not suffer capital loss, as you would receive interest and capital back from the government.
Gilt fund risk is the risk of government bond yields moving up and the risk of the fund manager making losses by taking wrong investment decisions. Hence, go for gilt funds that are run by experienced fund managers and take a longer-term view on interest rates when investing in gilt funds.
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