“Go long, longer, longest on government securities!” This sing-song phrase encapsulates a recurring theme in wealth management discussions around government securities (G-Secs). It might sound like a quirky mantra, but it highlights a pattern that has played out repeatedly in debt markets.
The story of G-Secs and their funds is as much about the excitement of returns as it is about the complexities of managing expectations. The tale begins in December 1998, when India witnessed the launch of its first G-Sec fund. The timing was less than ideal—equity markets were booming, leaving little investor interest for debt instruments. However, as the equity bubble burst, investors began reallocating funds, and by 2000, G-Sec funds had started gaining traction.
By December 2003, the returns from G-Sec funds were nothing short of spectacular. Some investors saw annualized returns of 17-18%. But how was this possible?
Understanding the Math Behind G-Sec Returns
Consider a simple example. Assume a G-Sec fund invested in a single 10-year G-Sec issued in December 2000 at a coupon rate of 10%, with prevailing yields also at 10%. By December 2003, yields had dropped to 5%. This 5% drop in yield translated into two components of returns:
- Coupon Income: Over three years, the investor would have earned 30% through annual coupons of 10%.
- Capital Gains: The drop in yields increased the price of the security. A simple thumb rule is that every percentage drop in yields gets multiplied by the security’s modified duration (in this case, six years). Thus, 5% x 6 = 30% capital gain.
In total, this resulted in an annualized return of approximately 17%.
The Flip Side of the Story
While early investors celebrated, the narrative shifted as yields began to rise. The price of the security—and therefore the fund’s net asset value (NAV)—started to decline. The earlier capital gains were gradually eroded, and new investors who entered during the hype often faced disappointing returns, sometimes even losses.
This paradox of losing money in a G-Sec fund, despite no defaults or delays, baffled many. But it underscores the inherent complexity of debt markets. Managing debt allocations requires careful navigation through interest rate cycles, making it arguably more challenging than managing equities.
Navigating the G-Sec Circus
So, what should investors keep in mind when considering G-Sec or debt fund investments?
- Track Records Across Cycles: Evaluate the performance of the suggested schemes over different interest rate cycles.
- Exit Strategy: Understand the implications of exiting after interest rates decline.
- Buy and Hold Benefits: A disciplined buy-and-hold strategy often yields stable results over time.
For instance, here are the 10-year returns from some well-known schemes:
- HDFC Short Term Fund: 7.87% p.a.
- HDFC Medium Term Fund: 8.08% p.a.
- SBI Gilt Fund: 9.39% p.a.
(These figures are for representation purposes; similar schemes from other fund houses may have delivered comparable returns.)
The Takeaway
In the world of investments, activity for its own sake rarely pays off. Every move should be time- and risk-adjusted to deliver meaningful results. Chasing themes without a comprehensive understanding of the underlying dynamics can lead to more harm than good.
Debt markets, especially G-Secs, may seem alluring, but they require cautious navigation. As with any investment, due diligence, patience, and a clear strategy are key to reaping long-term rewards.
