Average Portfolio Maturity helps an investor know how sensitive a debt fund is to changes in interest rates

This time we give you an insight into something that most debt fund investors would be unaware of, the Average Portfolio Maturity.

As we all know, debt funds invest in bonds and securities. These instruments mature over a certain period of time, which is called maturity. The maturity is the length of time till the principal amount is returned to the security-holder or bond-holder. A debt fund invests in a number of such instruments and each of these instruments would be having different maturity times. Hence, the fund calculates a weighted average maturity, which would give a fair idea of the fund's maturity period. For example, if a fund owns three bonds of 2-year (Rs 30,000), 3-year (Rs 10,000) and 5-year (Rs 20,000) maturities, its weighted average maturity would be 3.17 years.

What is the big deal about average maturity then, you may ask. Well, knowing a fund's average maturity is important because it tells you how sensitive a fund is to the change in interest rates. It is also important to keep in mind that change in interest rates affect different securities differently. The price of long-term debt securities generally fluctuates more than that of short-term securities when the interest rate changes. Consequently, mutual funds with several long-maturity papers in its portfolio are more sensitive to NAV fluctuations. For example, among all debt medium-term funds, DWS Premier has the highest average maturity (13.55 years as on April 30, 2008. As a result, this fund's standard deviation — a measure of a fund's volatility is also on the higher side. On the other hand, Canara Robeco has an average maturity of just 0.08 years and hence is least volatile.

The average maturity of a portfolio changes with time and also whenever the portfolio is churned. As a debt security approaches its maturity date, the length of time to maturity becomes shorter. Thus, even if a fund buys and holds a debt portfolio, the average maturity of a fund keeps on decreasing till the security held reaches its maturity date.

Also, if a fund sells one security and buys a fresh one, it is obvious that its average maturity will change. Gilt funds usually have a relatively higher average maturity and are the most volatile among all debt funds. Cash funds (debt ultra short term funds), on the other hand, usually have the shortest average maturity and are the least volatile. But we usually associate high risk with higher returns and hence, gilt funds are capable of delivering higher returns than other debt funds.

So if you are an aggressive investor, you know that gilt funds would suit your needs while cash funds are for the more stable investor.