As part of continuing efforts to increase retail participation in government securities and to improve ease of access, the RBI has decided to move beyond the aggregator model and provide retail investors online access to the government securities market.
Now, the access will be provided in both primary and secondary markets along with the facility to open their gilt securities account (Retail Direct) with the RBI. Details of the facility will be issued separately.
Encouraging retail participation in the Government securities market has been the focus area of the Government of India and the RBI. Accordingly, several initiatives viz. introduction of non-competitive bidding in primary auctions, permitting stock exchanges to act as aggregators/facilitators for retail investors and allowing odd-lot segments in the NDS-OM secondary market, had been taken in the past.
Providing direct access to government securities will provide a new avenue for retail investors and at the same time provide a channel for the government to fund economic growth, according to ICICI Direct Research.
“Providing retail investors a direct option to invest in government securities is a good development from a long term perspective,” says Lakshmi Iyer, CIO â€“ Debt & Head â€“ Products, Kotak Mahindra AMC.
“It may just be the beginning of a viable substitute for small savings schemes at market rates. However, much like sovereign gold bonds, likely pick up pace will be at a slow rate,” opines Mahendra Jajoo, CIO, Fixed Income, Mirae Asset Management India.
Usually, the government securities market is majorly driven by institutional investors like mutual funds, banks, insurance companies. Small investors are also allowed to bid for government securities via their demat accounts. But such access was allowed only to the secondary market in government securities via the Reserve Bank of Indiaâ€™s NDS-OM System. The latest move widens the access to both secondary and primary market segments. Primary markets are where a security is issued for the first time, while secondary markets are where buying and selling of already issued securities happens.
The Indian Finance Minister Nirmala Sitharaman in her Union Budget speech this year had proposed a debt Exchange Traded Fund (ETF) consisting of government securities. The aim behind this was to improve participation in the government securities (G-Sec) market. Sitharaman said “This will give retail investors access to government securities as much as giving an attractive investment for pension funds and long-term investors.â€
Recently, Motilal Oswal mutual fund launched Motilal Oswal 5-year G-Sec ETF (MO5GS). This is not the first G-Sec ETF. LIC Mutual Fund had launched LIC MF GSEC Long Term ETF in 2014. The maturity for these securities were more than 9 years. However, MO5GS is for a shorter term of 5 years. Investors with a low risk profile can consider this. However, there is a need to understand the difference between gilts funds and ETFs.
How ETFs help the G-Sec market?
Retail participation in the secondary G-Sec market is very negligible at present. G-Sec ETFs can help improve participation. How?
As you might know, an ETF is a basket of securities that tracks an underlying index. A G-Sec ETF investing primarily in government securities will mean that the government may prefer to borrow directly through ETFs from the secondary markets. Why? This is because ETF liquidity will be high as ETF investors will be pension funds and domestic institutions. Since ETF are listed in the market, the secondary market for G-Sec ETFs will improve and the better liquidity will help retail investors.
How are G-Sec ETF different from gilt funds?
Gilt funds and Gilt ETFs invest in a basket of G-Sec. Read this article to know more about gilt funds â€“ Are gilt funds as good as bank deposits? A Gilt ETF is a passive fund that tracks an index of G-Sec.
Gilt funds are available as open-ended funds or close-ended funds. ETFs are close-ended funds. So, you can invest in them during the New Fund Offer (NFO) tenure or you can buy them from the secondary market.
Since Gilt ETFs need to be purchased and sold through a brokerage account, you will need to hold them in the demat account. You donâ€™t need a demat account for gilt funds.
ETFs are traded through the day. So, ETF prices can fluctuate and vary sharply in the short term. Extreme price fluctuations are possible if there is market volatility. Gilt funds are less volatile when compared to G-Sec ETFs.
Here are points where G-Sec ETFs score over gilt funds.
Most gilt funds do have an exit load. If the redemption is done within a few months of purchase, exit load might apply. There are no exit loads for G-Sec ETFs. So, redemption comes ta no cost for ETFs.
Gilt funds do not disclose their portfolio holdings on a daily basis. You will need to see the fund fact sheet at the end of the month for the data. ETFs need to disclose their portfolio holdings on a daily basis. So, G-Sec ETFs are more transparent than gilt funds.
The expense ratio of ETFs is much lower as they are passively managed funds. So, gilt ETFs have lower management fees when compared to that of gilt funds. The lower cost of G-Sec ETF compared to gilt funds works in favour of investors, especially in a low interest rate regime. This also makes G-Sec ETFs potentially more attractive to investors who want to remain invested for the long term.
Note that gilt funds and ETFs have low minimum investment requirements. This makes them more suitable for retail investors.
Should you consider G-Sec ETF?
Understand that G-secs are long duration papers and are highly sensitive to interest rate movements. So, investors make money when interest rates fall. At present, interest rates have already been brought down by the Reserve Bank of India (RBI) to stimulate the economy. Rising inflation and revival of the Indian economy may push the yields up. This will push down the prices of government securities. This means that mark-to-market losses cannot be ruled out for G-Sec ETFs. So, if you can match the time horizon of your financial goal with that of the G-Sec ETF, you can stay invested and gain from the investment.
However, if you are looking for active fund management that will help you take advantage of government securities market movements, gilt mutual funds might be the ideal investments.
For most Indians, their first investment is often the bank savings account followed by fixed deposits. Fixed deposits are synonymous with safety, liquidity and convenience. It is simple to open a fixed deposit account at a bank where you have a savings account. You can link your savings account to your fixed deposit account. All these features have made fixed deposits popular in our country. However, given the recent problems of banks such as the YES Bank fiasco, gilt funds might actually be much safer than bank fixed deposits.
What are gilt funds?
Gilt funds are debt mutual funds that invest in government or government-backed securities. The government used to issue the bonds in golden-edged certificates. The nickname gilt comes from gilded edge certificates.
How are gilt funds better than deposits?
There are five points that an investor should note that makes gilt funds superior to bank deposits.
The first aspect is safety. Gilt funds are sovereign because they invest only in the Government of India securities. Gilt funds donâ€™t invest in securities other than government bonds, such as corporate bonds. The government securities could be central government securities or it could be state government securities.
However, they are all only government bonds. Gilt funds do not invest in rated securities that have credit risk, not even AAA ones. So, the money that you invest will be put in only government securities where the default risk is zero. However, bank deposits are guaranteed for only up to Rs. 5 lakhs even if you have several deposits in different banks or branches. There are risks of default by the bank in case there are any solvency problems for the bank. So, while gilt funds are sovereign investments, bank deposits come with an amount of credit risk.
Gilt funds have high liquidity. This is because of the ample demand for government bonds from institutions such as mutual fund houses, banks and insurers. In the debt market, government bonds are the most liquid of all the securities. Not only banks and mutual funds, even pension funds, trusts and Foreign Institutional Investors (FII) buy government bonds. So, there is no question of illiquidity for government bonds.
Better interest rate transmission
Gilt fund returns are derived from the movements of the market. Government bond is a market-driven financial security. So, generally gilt- funds are far more efficient than bank fixed deposits, especially when interest rates start increasing. When the Reserve Bank of India (RBI) starts to increase interest rates, government bonds reflect the rates much earlier and better than banks. Banks are very slow in passing on higher interest rates to depositors while they are quick to lower deposit rates. In fact, government securities often provide slighter higher rates than those of deposits.
Bank fixed deposit rates were about 7% a year back. Three years back, the interest rate for a three-year deposit was only 6.25% while five year back, deposit rates were 7.25%. Now, if you consider gilt-funds, they have given investors more than 9.9% in the past year. Their annualised returns over the past three, five and ten years is more than 9%. So, gilt-funds have provided returns that are much higher bank deposits if you are investing for the long term.
Bank deposits are taxed as per your tax brackets. If you fall under the highest tax bracket of 30%, then, bank deposits provide lower tax adjusted returns for you. However, gilt-funds provide better returns if you stay invested for the long term. Short-term capital gain (STCG) for gilt funds (when you hold the fund for less than three years) is as per your tax bracket. However, long-term capital gains (LTCG) will have a lower tax of 20% along with indexation benefits. The effective tax rates for most investors is often much lesser than 10% if they stay invested in gilt funds for more than three years. So, gilt funds are much more tax efficient when compared to bank deposits.
What about the volatility in gilt funds?
Even though gilt funds come with interest rate risks, the risks actually help provide higher returns. How? If you have a gilt fund and the interest rates increase from 6.5% to 7.5%. Then, you will see a drop in the Net Asset Value (NAV) of the fund. However, from that day onwards all the government bonds held by the fund will get re-invested at 7.5%. So, you will get more returns from gilt funds if you remain invested for the long term.