Here we explore and compare the yield-to-maturity of debt mutual funds and government bonds
Simply put, the yield of a bond or yield-to-maturity (YTM) as it is formally named, is the return that an investor can expect on buying a bond at its existing market value and holding it till its maturity. Likewise, the YTM of a debt fund is the weighted average yield of all the underlying bonds in its portfolio.
Effectively, YTM is a forward-looking metric indicating the expected returns from a fund if the entire portfolio is held till maturity. So, if the yield-to-maturity on a fund portfolio is 8 per cent and if all the investors remain constant and the fund manager does nothing, then you can safely assume that the yield-to-maturity minus expenses will be your return on the fund.
But that is not the reality unless you have invested in a closed-end fund where once the portfolio is constructed, the idea is to hold that portfolio till maturity with no intermittent inflows or outflows in the fund. In case of an open-end debt mutual fund, investors come in (bringing more money), a few go out (redeeming money) forcing the fund manager to make changes in the portfolio accordingly. Besides, there could be many other reasons due to which the fund manager may tweak the portfolio, e.g., a change in the interest rate outlook. And that's the reason why the return of an open-end debt fund doesn't match with the yield-to-maturity. Also, the return is a backward-looking metric telling about the actual returns generated by a fund over a specified time period.
Further, there are different types of debt mutual funds with different characteristics, investing in bonds of different durations. Depending on their mandate, some debt funds invest only in medium to long-duration bonds (with far-off maturity), some only in bonds with a shorter duration and some invest in a mix of both. Likewise, we have a debt mutual fund category (Debt: Gilt with 10 year Constant Duration) where funds invest only in government bonds of 10-year duration. The average yield-to-maturity of the category is 6.98 per cent, quite close to the yield-to-maturity of a 10-year government bond. A government bond with a 10-year duration (generally considered the benchmark in India) is currently yielding 7.38 per cent.
Check out our list of debt funds.
But if you look at the government securities of shorter duration, they are yielding less. For example, a government bond maturing in 2023 is yielding around 5 per cent and a 364 T-bill is yielding only 4.84 per cent.
Suggested read: A basic introduction to debt funds