Yield and Average Maturity in debt mutual funds

While investing in a debt mutual fund, there are two factors one should look at — average maturity and yield to maturity of the portfolio. These are the two variables most fund fact sheets and aggregators generally provide.

AVERAGE MATURITY:

It is the average of the maturities of all the debt instruments held in a fund portfolio. A debt mutual fund invests in various fixed income instruments such as government securities, government bonds, corporate papers and certificates of deposits. Each instrument has its own maturity date – the date on which the holder of the security is paid the original amount of money borrowed.
Average maturity tells the investors how sensitive a bond fund is to change in interest rates. When interest rates move down, the prices of the bond move up. That results in capital appreciation for the investors and boosts the returns on their debt fund portfolios.

On the other hand, when the interest rates move up, the prices of bond move down. This leads to a loss to the fund as the value goes down. If the portfolio of a debt fund is loaded with long-term bonds — high average maturity — it will be highly sensitivity to interest rates movements. If the interest rates were to move down in near future, the funds stand to gain.

Long-term bond fund managers typically push their fund's average maturity to the higher end if they expect the long-term rates to fall. If fund managers expects the rate of return to harden, they would usually prefers to keep the average maturity low.

Average maturity of the fund, however, does not indicate when the scheme matures. The open-ended schemes do not mature.

YIELD TO MATURITY (YTM):

This is the expected return the investor will generate if he holds on to the current portfolio till all the securities mature. It captures both the coupon payments and the capital gain or loss till the portfolio matures. It also assumes that the inflows in the form of coupon receipts and part payment of principal are reinvested at YTM. Investors looking to invest in a fund should look at YTM of the portfolio to get an idea of the possible returns.

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