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Tata Capital > Blog > Wealth Services > Is GSec Suitable For An Investor In A Rising Interest Rate Scenario?

Wealth Services

Is GSec Suitable For An Investor In A Rising Interest Rate Scenario?

Is GSec Suitable For An Investor In A Rising Interest Rate Scenario?

The RBI Governor proposed allowing retail investors to invest in G-sec i.e. Government Securities. These are instruments which garner a lot of faith among the investment community as they have a sovereign guarantee and have virtually nil default risk. Here we go through the nuances of how and who should invest in these instruments.

1. How can you invest in G-secs?

The Government recently launched the RBI Retail Direct Scheme in November 2021, which allows retail investors to directly invest in G-sec investments or G-sec bonds. Before this, the ideal means to invest in these instruments was via Gilt funds or G-sec funds, which in turn invested the pool of money in Government bonds or through traditional insurance plans which invested in G-sec pre-dominantly. To invest in G-sec the retail investor has to open a gilt security account with the RBI, which is also known as Retail Direct Gilt (RDG) Account. 

2. Documentation and process to open an RDG account:

The RDG account can be opened online by logging into the RBI retail direct website. The entire procedure to open the account can be done online, the following documents need to be submitted to the retail direct website.

  • Aadhaar card
  • PAN card
  • Rupee bank account details. 

Email and mobile number for periodic correspondence. The online KYC is also completed using the above documents, other details should be provided by the individual as required. 

3. Benefits of investing in Gsecs:

Some of the advantages of investing in G-secs are:
a. Fixed returns:
The G sec yields are guaranteed, and these instruments are considered risk-free to a large extent. The default risk is almost nil in the case of G-sec, this is often the foundation for many portfolios. Typically, whilst designing a portfolio, we look at risk-free or low-risk instruments, after which the exposure towards high-risk instruments is considered.

A 10 years G-sec is considered while designing a portfolio combining risk-free and risky assets. Now, with direct investment in G-sec being allowed, you can consider the exposure to this instrument as a founding stone to building a well-diversified portfolio. 

b. No cost for the account:
There is no fee charged for opening and maintaining the RDG account, and there is no limit on accessing and transacting on the portal. There are no charges applicable on transacting on this platform. The current model for investing in G-sec is G-sec mutual funds, and  mutual funds  involves a certain fee per transaction, besides there are expenses adjusted in the NAV while investing.

c. Discretion of selection:
The conventional mode of investing in G-sec often does not provide the investor with many choices in selecting the G-sec of your preference. However, when you go via this route, you can pick and choose specific G-sec bonds with preferred tenure, depending upon your cash flow needs. The flexibility available via this mode remains the highlight of this investment avenue. 

d. Sense of safety
The sense of safety that automatically overlaps your decision when you hear that your investment is somehow connected to the Government is incredible. This sense of security is a rare phenomenon in any other form of investment. For G-sec it is often the same feeling that you have when you invest in fixed deposits, the perception of risk is much lower than what is there in reality. A similar feeling descends when you talk about G-sec; the possibility of default by the Government is close to nil. This often is a critical factor which wins over an investor.

4. Disadvantages of investing directly into G-sec:

a. Interest rate risk: 
Although G-sec do not have credit risk or default risk, they are subject to interest rate risk. In a rising interest rate scenario, the G-sec bonds would face severe mark-to-market loss in the event the bonds are sold before maturity. It requires adequate knowledge and there may be times when the bond value drops sharply, which will unnerve a novice or inexperienced investor.

b. Limited diversification:
If one were to undertake the DIY approach to building the investments in G-sec directly, then the available cash flow diversification would be limited compared to something of the magnitude of mutual funds or traditional insurance. Mutual funds and traditional insurance have a large pool of funds, enabling better and more efficient diversification. 

c. Professionally managed:
The fund manager who manages G-sec funds or traditional insurance funds has years of experience and a very deep understanding of the debt markets, enabling him to navigate various G-sec bond yield scenarios effectively. As an inexperienced investor, there is limited possibility of tactical manoeuvre.

Further, the quantum of funds in these conventional modes of G-sec investment allows the fund manager to make strategic and tactical reallocations efficiently. However, a DIY investor may not enjoy this luxury.

d. Taxability:
Gilt mutual funds are under capital gains, wherein the indexation benefit is offered if an instrument is held for the long term. The proceeds from traditional insurance are typically tax-free at maturity. However, the Gsec yields from G-sec bonds are assessed under interest income which is charged at marginal tax rate.

Suitability Analysis

It all boils down to who should invest in these instruments. From a risk-return, this is an extremely conservative investment avenue. From a cost per transaction perspective, it remains attractive. Although, from a taxability perspective, you will be better off investing in mutual funds. 

Just like equity mutual funds, you need to strategically manage your investment in debt mutual funds. G-secs are best suited for the rising interest rate fund. Thus, it is ideal if you can invest in G-sec for the long term when the interest rates have peaked. This will help lock in high-interest rates over the long haul.

At the moment, this mode of investment is still in the nascent stages, and investors are trying to figure out its nuances of it. Further, the interest rate cycle is not conducive at this point for investment; it may, however, catch the attention of the investors as the interest rate environment turns favourable for such investments with high G-sec yields.

In a nutshell:

From the above note, it is apparent that G-sec funds are highly conservative instruments, they are an excellent place to start whilst you build a well-diversified portfolio. It is essential that you understand the workings of interest rates and the concept of duration before you dabble in debt instruments. You can choose to invest directly or via conventional modes based on your expertise, experience and knowledge level. Making an informed decision is an integral part of your investment journey. You can reach out to experts at Tata Capital Wealth, who can assess the best route and the right quantum of exposure for you.

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