Gilt Funds in India: What They Hold and Why NAVs Swing With Interest Rates

A gilt fund in India is about the simplest debt fund to describe and one of the trickiest to hold. It lends almost entirely to the government, so the chance of not getting paid back is close to nil. Yet its NAV can drop several per cent in a few weeks. Both statements are true, and once we see why, the fund stops being confusing.

This guide covers what SEBI’s rules say a gilt fund must own, why interest rates (not defaults) drive its returns, and how to estimate the swing in rupees before you put money in. Every rupee figure in the worked examples below is hypothetical, picked to make the arithmetic easy to follow.

What a gilt fund in India has to hold

“Gilt” is market slang for government paper. The RBI’s FAQ on government securities defines a G-Sec as a tradeable instrument issued by the Central Government or the State Governments, acknowledging the government’s debt. Short-term ones are treasury bills, with original maturities under a year. Longer ones are dated securities. State governments issue only dated securities, called State Development Loans (SDLs). The RBI notes that G-Secs carry practically no risk of default, which is why they are called risk-free gilt-edged instruments.

SEBI’s October 6, 2017 circular on categorisation of mutual fund schemes turned that idea into two fixed fund categories:

• Gilt Fund: at least 80% of total assets in G-Secs, across maturity. The manager can sit in short papers, long papers, or move between them.
• Gilt Fund with 10-year constant duration: at least 80% of total assets in G-Secs, such that the Macaulay duration of the portfolio equals 10 years. The manager has very little room to change interest-rate exposure.

The same circular allows only one scheme per category for each fund house, with exceptions for index funds and ETFs, funds of funds, and sectoral or thematic funds. So an AMC can’t run three look-alike gilt funds under different names. When you compare gilt funds, you’re mostly comparing one scheme per fund house.

SEBI’s table doesn’t spell out what goes into the remaining 20% or less, so check the fund’s monthly portfolio disclosure to see what it actually holds there.

Where the risk actually sits

Here’s the part that catches people out. Low default risk is not low risk. The RBI’s FAQ lists the main risks of holding G-Secs, and the first one is market risk: prices of the securities move with interest rates, which can cause losses when holdings are marked to market or sold at bad prices. It also lists reinvestment risk (coupons may have to be reinvested at lower yields) and liquidity risk (not finding a buyer at a fair price).

A mutual fund values its bonds at market prices every day. So when yields in the bond market rise, the price of the bonds the gilt fund already owns falls, and the NAV falls with it. When yields fall, the NAV rises. The RBI FAQ states the rule plainly: a bond’s yield is inversely related to its price.

A gilt fund rarely loses money because the government doesn’t pay. It loses money because someone else is now willing to lend to the government at a higher rate than the bonds in your fund pay.

Think of it from the buyer’s side. Suppose your fund holds a bond paying 7% a year and new government bonds now pay 7.5%. Nobody will pay full price for your 7% bond when 7.5% is on offer. Its price has to drop until the effective yield for a new buyer matches the market. That drop shows up in your NAV that evening.

Duration: the number that tells you how much it will swing

If you’ve read our explainer on bond duration, this will feel familiar. The RBI describes Macaulay duration as the time taken to recover the initial investment in present-value terms, expressed in years. Modified duration adjusts that figure and measures how much a bond’s value changes for a one percentage point change in yield.

The RBI gives a clean rule of thumb: duration is approximately the percentage by which the value of a bond will fall for a 1% per annum rise in market interest rates. Its own example: a 15-year bond with a duration of 7 years would fall roughly 7% if rates rose by 1% per annum. The approximation ignores convexity, so it gets less accurate for big moves, but it’s good enough to size the risk.

Every fund factsheet reports the portfolio’s modified duration, Macaulay duration and yield to maturity. Those three numbers tell you more about a gilt fund than its last one-year return does.

Worked example 1: two gilt funds, same rate move

Say you put ₹5,00,000 into one of two hypothetical gilt funds:

• Fund A holds long-dated G-Secs. Modified duration: 8 years.
• Fund B has moved into shorter papers. Modified duration: 2 years.

Now government bond yields rise by 0.50 percentage point across the curve over a few weeks.

• Fund A: approximate NAV change = 8 × 0.50 = 4% fall. On ₹5,00,000, that’s about ₹20,000 lost on paper.
• Fund B: approximate NAV change = 2 × 0.50 = 1% fall, or about ₹5,000.

Run it the other way. If yields fall by 0.50 percentage point, Fund A gains roughly ₹20,000 and Fund B roughly ₹5,000. Same issuer, same credit quality, four times the swing. That’s the whole story of gilt funds in two lines of arithmetic.

Worked example 2: the 10-year constant duration fund

SEBI fixes the Macaulay duration of this category at 10 years. Modified duration is a little lower. With semi-annual coupons, modified duration is Macaulay duration divided by (1 + yield/2), which is the formula the RBI’s own illustration uses. Take a hypothetical portfolio yield of 7%:

Modified duration ≈ 10 ÷ (1 + 0.07/2) = 10 ÷ 1.035 ≈ 9.66 years.

So a 1 percentage point rise in yields would cut this fund’s NAV by roughly 9.7%, and a 0.25 point rise by about 2.4%. On ₹5,00,000, a 0.25 point move is worth around ₹12,000 either way. Because the manager can’t shorten duration, there’s no escape hatch when rates turn up. You are buying a fixed bet on the 10-year part of the curve.

Worked example 3: carry versus price

Gilt fund returns come from two sources: the interest the bonds pay (carry) and the change in their prices. Here’s a hypothetical one-year view for Fund A:

• Portfolio yield to maturity: 7.0%
• Expense ratio: 0.6%
• Rough carry after costs: 7.0 − 0.6 = 6.4% a year

If yields stay flat all year, you earn something close to 6.4%. If yields rise 0.50 point early in the year, the price hit is about 4% (from example 1), so the year’s return lands nearer 2.4%. If yields fall 0.50 point, you could see something like 10.4%. Real outcomes won’t be this neat, because the portfolio changes and the yield itself resets as prices move, but the shape is right: carry is the steady part, price is the noisy part.

Carry is what you’re paid to wait. Duration decides how rough the wait is.

Gilt funds next to other debt fund categories

SEBI’s circular sets out 16 debt fund categories. A few useful comparisons:

• Overnight and liquid funds hold paper maturing in 1 day and up to 91 days respectively. Price swings are tiny. These are parking places, not rate bets.
• Short duration funds keep Macaulay duration between 1 and 3 years and can own corporate bonds, so they add some credit risk but much less rate risk than a long gilt fund.
• Long duration funds must keep Macaulay duration above 7 years. They can hold corporate bonds too, so a long gilt fund is the government-only cousin.
• Dynamic bond funds invest across duration, much like a regular gilt fund, but aren’t restricted to government paper.

A plain gilt fund can behave like a short-duration fund one year and a long-duration fund the next, depending on the manager’s call. That makes the current factsheet more important than the category name.

How it compares with owning G-Secs directly

You can now buy government bonds yourself. Our guide to RBI Retail Direct covers how. If you hold a single bond to maturity, the RBI notes that you can largely sidestep market risk, because you lock in the yield you bought at. Interim price swings don’t matter if you don’t sell.

A gilt fund has no maturity date, so there’s no point at which the price risk dissolves. The fund keeps rolling into new bonds. In return, you get daily liquidity, professional duration management and no need to handle coupons. If you want a fund that does end on a known date, a target maturity product is closer to holding a bond directly. Our piece on the Bharat Bond ETF explains how that structure works.

For the short end of the government curve, see how treasury bills are priced. The RBI’s own example there is a 91-day bill issued at ₹98.20 and redeemed at ₹100; the ₹1.80 difference is the investor’s return.

Who gilt funds suit, and who should skip them

We’d put it this way. A gilt fund makes sense when:

• You want debt exposure with essentially no credit risk.
• Your holding period is at least as long as the fund’s duration, so a bad stretch of rising yields has time to be earned back through carry.
• You’ve thought about where rates are heading, or you’re happy to accept swings both ways.

It’s a poor fit for an emergency fund or money you need in a few months. A sharp rise in yields at the wrong moment can leave you selling at a loss, even though nothing went wrong with the borrower.

A short checklist before you invest

1. Read the modified duration on the latest factsheet and multiply it by a plausible rate move (say 0.50 or 1 point). Can you live with that rupee loss?
2. Check the yield to maturity and subtract the expense ratio. That’s your rough carry.
3. See how much of the portfolio is in central G-Secs, SDLs and treasury bills.
4. For a regular gilt fund, look at how much duration has moved over the past year. A manager who swings it a lot is taking active rate calls.
5. Check exit loads and the current tax treatment of debt funds with a qualified adviser before you invest.

Gilt funds are honest products. They tell you exactly what they own, and the risk is the plain arithmetic of duration times rate move. Do that sum before you buy and the swings won’t come as a surprise.

Disclaimer: This article is for educational purposes only and is not investment advice. All investment amounts, yields, durations, expense ratios and returns in the worked examples are hypothetical. Mutual fund investments are subject to market risks; read all scheme-related documents carefully and consult a SEBI-registered investment adviser before making investment decisions.