Take a look at gilt fund returns over the past 12 months. No one can blame you if that's got you excited. Now you look at gilt fund returns over the past 6 months. No one can blame you if you are surprised. That's been the story with gilt funds of late, but few investors have made note of that.

Higher returns at higher volatility

Gilt (Long Term) Funds	NAV (Rs)	1-Wk	1-Mth	6-Mth	1-Yr	3-Yr	Incep	Std Dev.	Sharpe Ratio
FT GILT (IP) G	13.4	0.0%	2.7%	11.9%	27.5%	NA	23.1%	2.28	0.41
IL&FS GILT LP G	12.8	-0.1%	2.0%	11.8%	26.8%	NA	20.0%	1.94	0.40
BIRLA GILT LT G	19.7	-0.1%	2.2%	9.4%	23.8%	21.0%	20.5%	1.88	0.61
TEMPLETON GSEC G	20.8	-0.2%	2.3%	9.2%	23.8%	21.3%	20.4%	2.02	0.58
HDFC GILT LT G	14.2	-0.1%	1.6%	7.7%	22.1%	NA	20.7%	2.11	0.47

(NAVs as on June 3,˜03. Growth over 1-yr is annualized. Std Dev & Sharpe Ratio as on March 31, ˜03)

Frankly in these dull markets (equity markets have only now embarked on a surge and its anybody's guess how long that will last) a 20% growth is a sight for sore eyes. Its enough to make any investor hasten to apply for the scheme, especially a debt-related scheme. However, investors need to make note of some points before they do that.

Gilt funds aren't your regular income schemes mainly because they are exposed to interest rate volatility, which is more intense in govt. securities (gsecs/gilts) vis-à-vis corporate bonds. What this means is that while gsecs offer more comfort on the credit risk front, they more than compensate by offering little comfort on the interest rate front (read more volatility). As gsecs react more sensitively to interest rate fluctuations, inflation, oil prices, global economic slowdown, they carry an inherent risk otherwise known as Interest Rate Risk. This risk was more than highlighted in Jan-Feb 2003, when the debt market was turned on its head with intense price volatility that sent Gilt Fund (and Long Term Income Fund) NAVs crashing. That is why gilt fund returns have such high volatility (refer standard deviation in above table).

Another reason why we are unlikely to see 20%+ growth rates in Gilt Funds is because of the south-bound interest rate regime, which will make it extremely difficult for debt fund managers to duplicate such a performance going forward. Mr Nilesh Shah (CIO-Debt Franklin Templeton Investments) admitted as much in his interview to Personalfn after the latest Credit Policy was released in April 30, 2003.

Proof of fund manager's inability to sustain the overcharged performance of gilt funds can be seen in the 6-month performance vis-à-vis the 12-month performance (refer table). For instance, FT Gilt has appreciated 27.5% over the last 12 months, but only 11.9% over the last 6 months. HDFC Gilt Fund fell the brunt a lot more than its peers posting a mere 7.7% appreciation over 6 months vis-à-vis 22.1% over 12 months. That's been the situation with all gilt/income funds.

Does that make gilt funds an unviable investment proposition? Far from it. Gilt fund investors are still on solid ground with an investment horizon of 18-24 months. Over that period, volatility gets ironed out. But investors need to be disciplined and patient and tone down their return expectations going forward.

 

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