Why gilt mutual funds are struggling to gain popularity among retail investors

Gilt funds are a category of debt mutual funds that invest in Government Securities (G-Secs). These schemes hold a mix of government bonds with varying maturities. Since the securities are backed by the sovereign, these funds do not carry corporate credit risk, making the probability of default extremely low.

Gilt funds make money in two ways. One is through the interest earned on government bonds and through gains when bond prices rise. Since gilt funds often hold long-term bonds, they can deliver strong returns during falling interest rate cycles and perform better than other debt fund categories in such periods.

Rising bond yields over the last year have led to weak returns in gilt funds. Wealth managers say gilt funds are highly sensitive to interest rate movements and are best suited for investors who can make tactical calls at the right stage of the interest-rate cycle, as reported by ET Bureau.

While gilt funds carry negligible credit risk because they invest only in sovereign-backed securities, they remain highly sensitive to interest rate movements. Most gilt funds hold medium- to long-duration government bonds, whose prices can fluctuate sharply when bond yields move. As a result, returns could be uncertain, unlike fixed deposits or short-duration debt funds that offer relatively stable returns.

Since many retail investors in debt products prioritise stability and liquidity over interest rate directional bets, categories such as liquid, short-duration, and corporate bond funds tend to be more popular.

Gilt funds are best suited for investors who understand interest rate cycles. Since these tend to perform well when interest rates and bond yields fall, investors must aim to buy when bond yields are elevated.

Wealth advisors usually advise investors to accumulate when the 10-year benchmark yield is at 7.2%-7.3% levels. This product may not be suitable for investors seeking stability in returns or high liquidity.