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What are yield-to-maturity (YTM) and average maturity in debt funds, and how should investors use these metrics to evaluate a fund?
— Anonymous
Both yield-to-maturity (YTM) and average maturity are key metrics for evaluating debt funds, but they serve different purposes and provide unique insights into a fund's potential performance and risk.
Yield-to-Maturity (YTM)
YTM represents the return an investor can expect if the bonds in the fund's portfolio are held until maturity. For example, if a debt fund has a YTM of 8 per cent, it gives you an idea of the approximate return you might earn, adjusted for expenses, assuming no changes in the portfolio. However, in practice, actual returns may differ due to changes in the fund's portfolio by the manager, investor inflows or outflows and daily expense deductions reducing the effective return.
YTM is a helpful guide for setting expectations about potential returns from a debt fund based on the current portfolio.
Average Maturity
Average maturity is the weighted average of the maturities of all bonds in the fund's portfolio. For example, if a portfolio holds two bonds—one maturing in 10 years and another in 5 years, with equal weightage—the average maturity would be 7.5 years. This metric reflects the overall interest rate sensitivity of the fund. Funds with a higher average maturity are more sensitive to changes in interest rates. On the other hand, funds with a lower average maturity are less sensitive, making them more stable in a rising rate environment.
How to Use These Metrics?
- Use YTM to understand the potential returns a fund may offer.
- Use average maturity to assess the fund's sensitivity to interest rate changes. Higher the maturity, more will be its sensitivity to interest rate changes and in turn volatility. If you are investing for a shorter duration or during a rising interest rate phase, consider funds with a lower average maturity to reduce risk. If your horizon is longer, funds with higher average maturity can provide better returns during a falling interest rate environment.
Both metrics together can help you make a more informed choice depending on your investment horizon, risk appetite, and market conditions.
Also read: The difference between the average maturity and Macaulay duration of a debt fund
This article was originally published on November 26, 2024.
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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