Debt Funds help an investor diversify the portfolio and cushion the potential volatility of Equity Fund investments. It can be worrisome to see negative returns in debt investments while the overall fund is performing well. The reason is that debt funds are sensitive to market interest rate changes. So assessing the interest rate risk can help in minimising it. Critical parameters like Average Maturity, Macaulay Duration and Modified Duration can provide insight into how future interest rate changes can impact the funds’ overall performance.
What does Average Maturity mean?
As the term suggests, it is the weighted average of the maturity periods of all the bonds in a particular the fund. The weights are the percentage holdings of each bond/issuer in a scheme. A debt fund invests in bonds with varying maturity periods, so for every bond in the fund, it takes an x number of years for the principal amount to be repaid to the Bondholder by the Bond issuer. The average maturity of debt mutual funds, simply put, is the weighted average maturity of all the underlying bonds; so while each bond would take varying periods to mature, an average will give a fair idea of the maturity of the debt fund.
How is Average Maturity calculated?
Take a debt fund having Bond X, Y and Z. The following are the particulars:
| Bond X | Bond Y | Bond Z |
|---|
| Face Value | ₹10,000 | ₹5,000 | ₹20,000 |
| Years to Maturity | 2 | 3 | 4 |
| Weighted Total | 20,000 | 15,000 | 60,000 |
| Average Maturity | (20000+15000+60000)/(10,000+5000+20,000) = 2.71 years |
So the Average Maturity of the Debt Fund is 2.71 years, although each bond will mature at different periods.
Average Maturity - How can it be interpreted?
There is a correlation between market interest rates and bond prices; if the market interest rate falls, the bond value tends to appreciate, and if the market interest rate increases, the bond value tends to depreciate. So given this logic, the longer the average maturity of a debt mutual fund, the higher its susceptibility to the interest rate risk, and the shorter the average maturity, the possibility of risk could be potentially lower.
↑ Market Interest Rates ↓ Bond Prices
↓ Market Interest Rates ↑ Bond Prices
Why is Average Maturity important?
The relationship between market interest rates and bond prices forms the basis of the Duration Strategy in Debt Funds. In case of a fall in the interest rate , the investment in Debt funds with longer Average Maturity must be increased. And to aim to minimise the risk of rising interest rates, investments in debt funds with low Average Maturity must be increased. So understanding the Average Maturity in debt mutual funds can aid in better management of the debt fund.
↑ Average Maturity = ↑ Interest Rate Sensitivity
↓Average Maturity = ↓Interest Rate Sensitivity
Average Maturity supports the better management of debt funds. The potential risks can be mitigated, and the returns can be optimized by understanding the correlation between bond prices and interest rates and using this parameter.
Disclaimer:
The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their affiliates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken on the basis of this document.
Mutual Fund Investments are subject to market risks, read all the scheme related documents carefully.
