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What is average maturity?

Investing in a bouquet of securities and assets is a suitable way of diversifying one’s portfolio. However, when investing in the debt market, it is crucial to align the ‘average maturity’ of the portfolio or fund with one’s objectives, investment horizon, and risk appetite. Thus, understanding the concept of average maturity is crucial to making informed investment decisions, especially when it comes to debt instruments.

Understanding average maturity

Think of your investment portfolio as a diverse collection of assets like bonds, fixed deposits, or debt funds. Each asset has a specific maturity date, indicating when you will potentially receive your principal amount back. The average maturity definition states that it is the average time it takes for all underlying bonds or debt instruments to mature and return your principal investment. Therefore, the average maturity indicates how long it takes to access your invested capital.

Here are the implications of the average maturity meaning on your investments:

Interest rate sensitivity: Funds with longer average maturities are generally more sensitive to interest rate fluctuations. Rising interest rates can decrease the value of your existing bonds, potentially impacting your returns. Conversely, falling rates can be beneficial to the value of existing bond holdings.

Investment horizon: Matching your investment horizon with the average maturity is crucial. Choose funds with maturities aligned with your goals, be it short-term needs or long-term wealth creation.

Risk profile: Shorter maturity periods generally indicate lower risk, as you receive your principal back sooner. Conversely, longer maturities offer a relatively higher return potential but with increased risk due to the vulnerability to interest rate changes.

There are two methods to calculating the average maturity:

Weighted average maturity (WAM): Considers the investment amount in each bond, giving greater weight to larger holdings. This method reflects the average time until you receive the weighted average of your principal investment.

Macaulay duration: Takes into account both the time to maturity and the coupon payments received throughout the bond's life. It provides a more comprehensive picture of the bond's sensitivity to interest rate changes.

How to use average maturity?

Consider average maturity alongside other factors when evaluating a debt fund. The fund's overall risk profile and investment strategy are crucial considerations before making an investment decision. Even funds with similar average maturities may vary in risk due to factors like credit quality and issuer diversification. Always seek personalised guidance from a financial advisor to choose debt funds aligned with your specific needs and risk tolerance.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.