Don’t Invest Blindly Into Gilt Mutual Funds!

The RBI’s repo rate cut has made gilt mutual funds look attractive, but blindly investing now can expose you to volatility and unexpected losses.

The RBI’s recent repo rate cut has made headlines — and so have gilt mutual funds, which invest exclusively in government securities (80%). With long-term gilt funds showing sharp upward movements, many investors are now tempted to ride the wave. After all, gilt funds are considered safe in terms of credit risk, and with interest rates falling, they seem like a no-brainer.

But wait — there’s a lot more beneath the surface. While gilt funds offer high potential during falling interest rate cycles, blindly investing in them without understanding the risks can lead to regret.

Refer to the historical repo rate of RBI – RBI Repo Rate History from 2000 to 2025

RBI Rate Cut: Don’t Invest Blindly Into Gilt Mutual Funds!

Why Gilt Funds Are in the Spotlight

Gilt funds invest in central government securities, which are considered free from default risk. As per the definition of Gilt Funds, they have to invest around 80% of the portfolio in central government bonds. When the RBI cuts rates, the yield on these bonds falls, and their prices rise (price Vs bond yield is always inverse in relation) — especially the ones with long maturities. Gilt funds benefit from this rise, which is why their recent returns look attractive.

But high returns in the past don’t guarantee future performance — and that’s exactly where the risk lies.

1. Interest Rates Won’t Keep Falling Forever

Gilt funds are highly sensitive to interest rate movements. Yes, the RBI has cut the repo rate now — but future moves depend on inflation, fiscal deficit, global crude prices, and other macro factors. If inflation rises again, or if global conditions tighten, rate cuts may pause — or even reverse.

In that case, long-duration gilts (and funds that hold them) can face sharp capital erosion.

2. Gilt Funds Have High Duration Risk

Gilt mutual funds, especially long-duration and 10-year constant maturity funds, carry very high duration. That means a small upward move in interest rates can cause significant negative returns. Forget about the 10 year constant maturity funds, if you check the portfolio of many of the available gilt funds, you noticed that the average maturity of these bonds is more than 10 years.

For example:

• A fund with a modified duration of 7 could lose around 7% in value if yields rise or fall of interest rate by 1%.
• Macaulay duration is another way of understanding volatility. Macaulay Duration is a measure of how sensitive a bond (or gilt fund) is to interest rate changes. Think of it like this: If you invest in a gilt mutual fund, Macaulay Duration tells you how long (in years) it will take, on average, to get your money back from all the interest payments and the principal. But more importantly for investors, the higher the duration, the more the fund’s value will swing when interest rates change. So, when RBI cuts the repo rate, long-duration gilt funds gain more — their prices shoot up. But if rates go up, these same funds fall more sharply than short-duration ones. That’s why blindly jumping into high-duration gilt funds after a rate cut can be risky — if rates rise again, you could face losses.

This kind of volatility can be shocking for conservative investors who expected “safe returns from government bonds.”

3. Past Performance Is Not a Reliable Indicator

A common trap: Seeing recent 1-year returns of 10% or more in gilt funds and assuming the trend will continue. But often, by the time retail investors enter, the bulk of gains are already priced in. Bonds move in anticipation of rate cuts — not just after the fact.

Entering gilt funds after a rate cut can sometimes mean buying high, which leaves little room for further upside.

4. You Still Need a Long Investment Horizon

Even though gilt funds carry no credit risk, they are not meant for short-term investors. Their volatility makes them suitable only for those with at least a 10+ years horizon.

Hence, exploring gilt funds for your short-term goals is highly risky.

5. Taxation Has Changed, Returns Aren’t as Attractive as Before

With the 2023 change in debt fund taxation, gilt funds no longer enjoy indexation benefits. They are now taxed at your income slab rate, just like fixed deposits. For those in the 30% tax bracket, this significantly reduces post-tax returns.

So while returns may look attractive before tax, the net benefit might not be much better than safer, more predictable alternatives.

So, Should You Avoid Gilt Funds?

Not necessarily. Gilt funds can play an important role in a debt portfolio, especially when rate cuts are expected. But the key is:

• Don’t invest blindly based on past returns
• Understand your risk tolerance and time horizon
• Know that volatility is part of the deal, even with “safe” government bonds
• Prefer target maturity gilt funds if you want more predictability
• By investing in Gilt Funds you are just avoiding the credit risk. Interest rate risk is always there.

Conclusion –

Gilt funds are often misunderstood. They’re low on credit risk, but high on interest rate risk. A falling rate environment does create opportunities — but only for those who know what they’re getting into. If you’re investing just because everyone else is, or because a fund delivered 10% last year, hit pause. Understand the product. If your goal is 10+ years, then only explore.