Short-term gilt funds v/s floating rate funds: Which is safer?
What's the story
Investors often find themselves torn between short-term gilt funds and floating rate funds when it comes to safer investment options. Both have their own benefits and risks, making them attractive to different kinds of investors. While gilt funds invest in government securities with a fixed interest rate, floating rate funds invest in instruments with variable interest rates. Here's a look at the two options.
#1
Understanding short-term gilt funds
Short-term gilt funds invest in government securities with maturities of up to three years. They are considered low-risk as they are backed by the government. These funds provide a fixed return, which makes them predictable for investors looking for stability. However, the returns can be impacted by changes in interest rates, which might lead to fluctuations in the fund's NAV.
#2
Exploring floating rate funds
Floating rate funds invest in debt instruments with variable interest rates that reset periodically. These funds are designed to benefit from rising interest rates as they adjust their yields accordingly. Floating rate funds tend to be less sensitive to interest rate changes compared to fixed-income securities, making them an attractive option during periods of rising rates.
#3
Comparing risk factors
The risk profile of short-term gilt funds is mainly linked to interest rate movements and credit risk (though minimal, given government backing). Floating rate funds, on the other hand, are less affected by interest rate changes as their yields adjust with market rates. However, they may expose investors to credit risk from underlying securities.
#4
Evaluating returns potential
While short-term gilt funds provide stable returns, they may lag behind during periods of rising interest rates due to fixed yields. Floating rate funds can offer higher returns during such times as they benefit from upward adjustments in interest rates. However, returns are not guaranteed and depend on market conditions.
Tip 1
Choosing based on investment goals
Investors should consider their risk appetite and market outlook when choosing between these two options. If you prefer stability and lower risk, short-term gilt funds may be more suitable. If you're willing to take on some risk for potentially higher returns during rising rate environments, floating rate funds could be a better fit for your investment strategy.