Gilt Funds vs Debt Funds: Difference, Review, Performance & Returns

We have already discussed different kinds of mutual funds in our previous posts. This time we thought of sharing our reviews on Gilt Funds vs Debt Funds, their difference, performance and investment methodology of both types of funds. Gilt Funds and Debt funds are two important investment vehicles for risk averse people.

Let’s dig deeper into What are Gilt Funds? How are they different from other mutual funds?

Gilt Funds: Meaning

Gilt Funds are the class of mutual funds which invest all its money in government securities for medium to long term period. The fund is most suited for risk-averse investors who are not comfortable with investment risk in stocks. Gilt funds are almost risk-free investment because it invests only in high-quality government securities which are sovereign rated. There is no risk of erosion of capital.

Debt Funds: Meaning

Debt Mutual Funds invests in different categories of debt securities like Government Bonds (central & state govt.), Corporate Bond, Money Market Securities, Treasury Bills of different maturity date and have fixed interest payment.

Debt Mutual Funds are categorised into various types like Dynamic Bond Fund, Short Term Debt Fund, GILT Funds etc. Every Debt Mutual Fund carries a credit risk rating assigned by external rating agencies, which indicates the creditworthiness of the borrowers. A fund with AAA credit risk rating implies high safety of capital and less risk volatility and can be compared with a Fixed Deposit.

Gilt Fund comes under the classification of the debt fund, but here we will compare it with other type of debt funds. 

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Gilt Funds vs Debt Funds: Investment Approach

Gilt Funds invest entirely in G-secs with different maturity date. It helps the fund to balance the volatility of Interest rate risk. The composition of the fund includes Sovereign rated securities from Central and State govt.

While Investment under Debt funds has two classifications, short-term debt funds and long-term debt funds.

Short-term debt fund invests in Commercial papers, certificate of deposits and bonds with shorter maturity period. The main objective of the fund is to pocket interest income and is least affected by the change in Interest Rate.

Long term debt funds invest in securities issued by the government and corporate with longer maturity period. The investment purpose is earning interest income and gains from price fluctuations from the change in interest rate. The fund is actively managed to adjust the volatility of fund arising out of change in Interest rate.

Gilt Funds vs Debt Funds (Other): Risk Factors

All categories of debt funds have three types of risk:

• Interest Rate Risk
• Credit Risk
• Liquidity Risk

The risk factor in Gilt Funds is considered to be least compared to other type of debt funds. The fund is only exposed to Interest rate risk. As the fund’s portfolio consist of G-Sec which all are sovereign rated, it has no credit risk.

Debt Funds carry a considerable amount of risk to investment than Gilt Funds. As the fund invests in different risk rated securities issued by govt. bodies and corporate, credit risk and liquidity risk for the fund increases. If the fund’s rating is deteriorated/upgraded then there will direct impact in the price of the fund. During an economic downturn, corporate bonds are worst affected and in 2008 recession, the yield of corporate bonds of different risk grade increased sharply.

Gilt Funds vs Debt Funds: Performance and Returns

The primary source of income for both fund type is interest income. But, real return differs due to change in interest rate. The change in interest rate directly affects the price of bonds as the bond price and interest rate is inversely related.

Debt funds are more volatile to interest rate change than Gilt Fund. Over the long term, Gilt funds and Debt funds have given close to the same return with variation in return in short term period. This is evident from the table below in which returns from 1 yr to 10 yrs have been compared.

Gilt Funds vs Debt Funds: Summary

The visible difference in both types of funds is in the composition of the portfolio. Gilt Funds have an advantage over Debt Funds in terms of return and are most suitable for risk averse investors. An investor should choose their investments in both categories of debt funds wisely keeping in mind factors like taxation, risk. etc.

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Hope now you are clear about Gilt Funds and other Debt fund types. Which investment alternative do you prefer? Are you comfortable with a safer investing option? Or do you wish to explore a variety of investments around? Feel free to discuss in the comments.