The Mutual Fund Show: Why Gilt Funds Can Be An Alternative To Fixed Deposits
Most Indians invariably get initiated into savings through bank fixed deposits. They’re popular, simple to operate and less risky. But offer lower returns compared to other investment products.
One can replace bank deposits with gilt funds, Vijay Mantri, chief investment strategist at JRL Money, said on BloombergQuint’s weekly series The Mutual Fund Show. Gilt funds are debt mutual funds that invest in government or government-backed securities.
The credit quality and safety of such funds are one step ahead of fixed deposits, Mantri said, adding they also have high liquidity as a result of ample demand from institutions like mutual fund houses, banks and insurers.
That apart, these funds have managed to deliver better returns than fixed deposits, he said.
“If you look at the last one, three, five, seven and 10-year periods, fixed deposit returns have been 6.8%, 6.25%, 7.25%, 8.75%, 7.25%,” Mantri said. “In contrast, gilt fund returns during the same period stood at 9.96%, 7.98%, 9.04%, 9.54%, 8.94%. Net of taxes, gilt funds have delivered anywhere between 40-120% more return to investors.”
Watch the full show here:
Here are the edited excerpts from the interview:
In this episode, we want to focus on viewers who want returns higher than inflation, but with a certain degree of certainty. Is there a solution other than fixed deposits?
Mantri: Yeah, that’s very true. And before I start, I would like to pause, and would request the audience to even after the show just pause and think about what will happen to the retirement goals or any goal they have if the interest rate continues to remain low or starts falling in India? If the interest rate goes to 4% and fixed deposit interest goes to 3% or 2%, then what happens to their retirement goal? Do they have a solution to achieve their retirement goals? That is one question.
Second question, which is equally very important, is that any business can be funded basically through two routes—one is equity capital, which is riskier, and second is debt capital. When you invest in India in fixed deposits, you don’t get the return of the debt market, and I’ll explain you that through some numbers.
There are alternatives available which are better than fixed deposits and less risky than fixed deposits, provided somebody has a vision of at least three to five years. Today we are talking about gilt funds. Gilt funds invest in the Government of India securities only. They do not take exposure to corporate bonds, whether AAA or AA. They just invest into Government of India securities.
So, credit quality wise, they could be one notch above fixed deposits, but gilt rates are derived from the market participants. It is a market-driven rate, and are generally far efficient than bank fixed deposits.
Gilt funds, you’re saying, invest only in government securities, which means the risk of them going bust, or not honoring commitment is almost next to zero because they are quasi-sovereign?
Mantri: They are not quasi sovereign. They are sovereign because they’re investing only in the Government of India securities. So, the government securities—it could be central government securities, or it could be state government securities. And if you look at the entire debt market, the most liquid asset category is the Government of India bonds because not only the mutual fund industry buys these bonds, but banks also have to buy these bonds under SLR, insurance companies need to buy these bonds to protect the investor from the long-term interest rate downward journey, pension funds buy these bonds and FIIs buy these bonds. So, there’s a huge demand for these bonds on a regular basis. Even the various trusts buy these bonds. So credit quality wise, they are one step ahead of the fixed deposits because when people go toward the fixed deposits or anything they are looking at maybe perhaps top-notch private banks or public sector banks to put their money but after some time and the concern about the credit quality disappears; then people start chasing returns and that is why people go into to cooperative banks because for them, they can’t differentiate between a PNB, and perhaps a PMC Bank, but in gilt funds, you don’t have those kinds of challenges.
What are the current rates for an average gilt fund versus an average fixed deposit?
Mantri: We have done some number crunching. So what we have done here is that we’ve looked at the last one year, three years, five years, seven years, 10, 15, 20 years. What we did here is that we looked at what was the fixed deposit rate, one year back. So, one year back around the same time the fixed deposit rate was 6.8%. So if somebody invested at that time Rs 1 lakh, the net of that has become around Rs 1,04,000. Similarly, we have looked at what was the fixed deposit rate three years back, around the same time in 2017. It was 6.25% for a three-year fixed deposit. Then we took that number and then we looked at five years back, 2015, a five-year fixed deposit empty was at 7.25%, seven years back in 2013 the fixed deposit rate 8.75%.
So, the point I’m saying that we took actual SBI fixed deposit rates- from one year back, three years back, five-seven years back and even 10 years back. So, what was there in 2010? It was 7.50% for a five year period, then we assumed that after five years in 2015, again, we took five-year interest rate and at that time it was 7.25% and we did similar things for 15 years and 20 years. What you see, net of taxes, the value in fixed deposits after one year, Rs 1,00,000 has become a Rs 1,04,000 in three years, it is Rs 1,13,000 and in five years it is Rs 1,28,000 and in 10 years, it is Rs 1,65,000.
But if you look at the gilt funds in the same time period, and these numbers are for the entire mutual fund industry - we haven't picked up some best-performing fund or worst-performing fund. These are returns for all gilt funds managed by the mutual fund industry. So, last one-year return in gilt funds has been 9.96%. Last three years, it has been close to 8%, five years has been 9%. Keep in mind these returns are compounding so when we say five years, it is 9% compounding. If you look at 10 years it is close to 9%, and 20 years close to 9%. So if you see the return which could have generated Rs 1,00,000 net of taxes, if you look at the various time periods, gilt funds have delivered anything between 40% to 120% more than the fixed deposits during the same time period. And you could look at any time period as long as the investing horizon is three to five year plus.
Why did you say gilt funds are less risky than fixed deposits?
Mantri: See, as I told you that if it is a nationalised bank, then there’s no problem on the fixed deposit. But why do people go for cooperative banks? Because they’re offering 2% more than the nationalised banks.
So, when people will start buying corporate fixed deposits or when people will start buying bank fixed deposits, we have seen that they first look at the top ranking bank and then do a fixed deposit there but after some time they go on the slippery path of chasing returns and in that process they compromise the concept.
But suppose you’re investing in gilt funds for the last 10 years, 15 years, 20 years and you see a 8-9% return, absolutely there’s no need for you to migrate to anything beyond these product as long as your investment horizon is five-year plus. So, I am saying from that perspective it is a much better thing to do than investing in fixed deposits. Fixed deposits can be done if the time period is shorter but in India we have people doing three to five year fixed deposits but after three to five years, the fixed deposit gets mature and then they get re-invested again. So, the fixed deposit holding period is not three to five years, it is an optical illusion. The fixed deposits holding period is actually 30-40 years, more fixed deposits are renewed than new fixed deposits are being made.
We’ve compared fixed deposits returns—one year back what was the fixed deposit rate, three years back what were the fixed deposit rates, 10 years back what was the fixed deposit rates and what the value is. If you have invested Rs 1,00,000 during these various time periods, one year to 10 years back, it shows the value, the gilt fund returns during the same time period... For calculation purposes, I have taken 30% tax slab for fixed deposits, and for gilt funds I have taken 20% plus indexation. These numbers for the gilt funds are for the entire mutual fund industry, so these are average numbers. In this you have funds which are charging 1.5-2% expenses and you have constant maturity funds where expenses charges are around 20 basis points only. If you go for a constant maturity plan, I think the returns could be much better than these numbers show.
How can this be possible that no matter what happens; I as an investor will benefit? The G-sec or gilt funds surely should have some instance when they will not be able to give adequate returns, right?
Mantri: The only chink is the volatility.
Suppose interest rate goes up by a mere 1% or 1.5%, then you will immediately see 4-5% drop in the NAV of the fund.
So, perhaps you will not see return for one year. We have seen gilt fund not delivering return for two-three years, and single digit returns in gilt funds. Only in a five-year period and above, a gilt fund starts showing performance. So, one is that there is temporary volatility in the gilt fund.
Second, suppose you’re buying a 10-year G-Sec paper or a 10-year G-Sec fund in a private portfolio and if the interest rate goes up, you’re actually not bothered about it because you know that whatever the interest rate is at which you bought this G-Sec paper, you are bound to get interest every six months and you’re going to get your principal back. Suppose you buy the same G-Sec fund and the interest rate goes up; suppose currently it is around 6% and it becomes 7%. So what will happen immediately is, you’ll see some dip in the NAV immediately, but from that day onward the accrual starts happening at 7% instead of 6%. And all coupons get re-invested at 7%.
So this is the magic that many people don’t even know because it is not being marketed to investors and it is a very ironic and a sad statement that all of us, including advisers and the mutual fund industry that this category which delivered close to 8-9% over a 10-15, 20 years and the total asset under management is just Rs 11,000 crore for the entire mutual fund industry.
In different points of time wherein maybe the fixed deposit rate was higher than the G-sec yield as well, have G-Sec yields over a longer period tended to deliver? And let’s say somebody is convinced with this argument, should she or he invest into a gilt fund only with a slightly longer time horizon?
Mantri: Gilt fund investment has to be done with a longer period of time horizon and people need to inculcate the habit of doing SIP in gilt funds and then invest regularly- that is point number one.
Point number two, we have seen a very brief period where the interest rate was higher than gilt funds but after some time, either the gilt fund catches up, the yield catches up or the fixed deposit interest rate has fallen, but what is most important is what I told in the beginning - when you invest in a fixed deposit in India, you are not participating in the debt market in India, and let me give a simple illustration.
Suppose you are a borrower with a bank or any company; suppose you’ve taken a loan of Rs 1 crore from one organisation and from the same organisation you’ve put a fixed deposit, 10 years ago. So on the borrowing you’re paying 10% and on the fixed deposit, you are getting 8.25%, so you are net negative 1.75%. Suppose nothing has changed, so the gap between borrowing and lending remains at 1.75%, but what dramatic thing has happened is the floating rate. So when the interest rate drops in India, it immediately gets dropped on the fixed deposit but the interest rate drop doesn’t happen immediately. When the interest rate rises, on your loan interest rate rises immediately, and on your fixed deposit the interest doesn’t rise that immediately. So, I have done it and in my own experience, I’m telling you that the 1.75% gap doesn’t remain there. It inches 2% to 2.25%.
So I’ll give the same illustration, you’ve taken a Rs 1 crore loan from a bank. You are paying Rs 10 lakh at a rate of 10%; so you pay Rs 1 crore to the bank. The bank gives you a 8.25% fixed deposit interest, so you’ve got Rs 82,50,000 with a net loss of Rs 17,50,000. Now suppose FD interest rate has come down. So, the gap of Rs 70,25,000 has become Rs 24 lakh against you. It means that the interest rate in fixed deposit has fallen faster and on the loan it has risen much faster.
So just keep that in mind, if you are a borrower in India and an fixed deposit depositor, you are a double whammy because on the loan side, you pay the market rate but on the fixed deposit side you don’t get the market rate.
And if we just invest in fixed deposit alone, then you’re extending your retirement age from 60 years to 72 years. So lazy fixed deposit makes you work for 8 to 10 hours or more in your working life, just keep that in mind.
Would you as an adviser say that if I have a fixed deposit of Rs 10 lakh and if I have a car loan which is of Rs 10 lakh, is it better for me to break my fixed deposit and pay off the car loan?
Mantri: It’s much better to do that and it’s still better instead of putting it in a fixed deposit, you put it in a gilt fund because with the car loan, suppose you are a businessman, you can take income tax benefit of the interest you’re paying, and on the personal account on the G-sec, you can get a much more tax efficient return, so you can do that. But if you’re really concerned about the volatility, then pay your loan first.