With falling interest rates, long-term gilts may generate good returns. Here's how you should invest in them.

 

Owing to a strong possibility of a rate cut by the Reserve Bank of India (RBI), long-duration gilts and gilt funds have started rally ing. Most long-duration gilt funds have generated an absolute return of more than 3% in the past one month. Experts feel the momentum will continue for some time. Given that rates are expected to trudge downwards in the coming days, returns from bond funds are likely to go up. So, investors should consider gilt funds now. Bond yields and prices are inversely proportional--prices go up when yields fall and vice-versa. The general expectation is that the RBI will cut rates by 25 basis points on 5 April and further cuts could happen in the coming meetings.

Retail investors' interest in government securities has remained elusive, and gilts have been the sole preserve of institutional investors. This is because of a high investment threshold of `10,000 and a relatively complex investment process. However, the government and the RBI is looking to sort out some of the problems in the coming months by facilitating more investments through stock exchanges and providing retail investors access to the NDS-OM trading platform-currently available to only institutional investors.  The government may be trying to get retail investors more active in debt markets by having them get used to the safest of debt securities--government debt.

Given the falling interest rate regime and the thrust on making the investment process easier, gilts are beginning to look attractive.The question is: should you invest in gilts directly, or via gilt funds?

Direct investing

You can invest in G-secs (government securities) through banks or via dealers such as ICICI Securities PD and IDBI Gilts. You need to open a CSGL (secondary constituent's subsidiary general ledger) account with your bank to hold all government securities in an electronic form. If you have a demat account and a bank account with Netbanking facility, you can also invest in G-secs through IDBI Bank's Samriddhi G-sec portal. The same can also be done via IDBI's ATMs.

Direct investment will fit the bill of investors looking for fixed, regular pay-outs in the form of interest payments.  G-Secs are safe as there is a guarantee by the government. Also, there are no intermediary costs to be borne as the retail investor is buying directly from the government,". The category average of g-sec fund returns (8.63%), falls below the government bonds index return (9.27%).

Gilt funds

Those not comfortable with investing in gilts directly can opt for gilt funds. Investing in gilt funds is the same as investing in any mutual fund scheme. You can either visit the fund house's site directly or approach a fund distributor. In terms of ease of investing, gilt funds clearly score over the direct mode Even if the government promotes retail par ticipation, investment through the mutual fund route will continue to be a far more convenient way of investing in gilts.

Tax implications

Currently, the listed bonds and gilt funds are taxed differently. The main disadvantage of direct gilt holding is that the interest or coupon received before the scheme's maturity will be taxed as per the investor's slab rate. If you make capital gains after holding the security for one year, you will have to pay a capital gains tax of 10%. Indexation is not allowed because gilt is an interest-bearing security.

Till recently, there was a capital gains tax benefit if you invested in government debt through gilt funds. But now, for shorter hori zons, it makes sense to use the direct investment route. The tax advantage of non-equity funds has ceased after the government increased the holding period for claiming long-term capital gains tax benefits from one to three years. Now, you are liable to pay a tax of 20%, after indexation, on longterm capital gains. Short-term capital gains are taxed at marginal rates. So, holding period becomes critical. If your investment horizon exceeds three years, gilt funds hold the tax edge. This is because the interest received by the fund will also be counted as capital gain in your hand.