Gilt funds lose sheen as interest rates continue to remain high

Fund officials expect gilt funds sales to remain low as there are no signs of a rate cut in the medium term.

With the expectations of rate cut by RBI waning, gilt funds are expected to see tepid inflows in the coming months. The market was expecting that either the repo rate will be left unchanged or reduced. However, the RBI governor hiked repo rate by 25 basis points from 7.25 per cent to 7.5 per cent to contain inflation.

Gilt funds saw decent inflows in the last two months on the hopes of a rate cut. In fact, fund managers had raised the average maturity in their portfolios on expectations that the central bank will cut policy rates. As a result of which, the industry saw an improvement in gilt fund sales. Gross sales in gilt funds which stood at just Rs 414 crore in June shot up to Rs 1028 crore and Rs 1764 crore in July and August, respectively taking the gilt funds AUM up by 143% from Rs 3660 crore in March 2012 to Rs 8890 crore in August.

According to Morningstar data, long term gilt funds increased the average maturity from 9.45 years to 11 years in August. Intermediate gilt funds increased their average portfolio maturity from 7.90 years to 9.6 years. This was similar in the case of bond funds too. “We have been recommending staying away from gilt funds. Fund managers had raised average maturity in their portfolios in the expectations of a rate cut but were caught unawares. Gilt funds are very prone to interest rates risk,” said Dhruva Raj Chatterji, Senior Investment Consultant, Morningstar India.

“The interest in gilt funds is waning. The inflows in gilt funds will be driven by RBI action,” said Sarath Sarma, Executive Director, Head – Sales, IDBI Mutual Fund.

Currently, there are 43 gilt funds with assets under management of Rs 8890 crore as on August, 2013. Bond prices and yields move in opposite direction. Fall in interest rates benefits gilt fund which see a spike in their NAVs. According to Value Research, over a three month period, medium and long term gilt funds have delivered negative 4.22% returns.