Average maturity is the sum of the declared maturity dates of the portfolio's debt instruments for a bond fund, additionally known as average weighted maturity. Generally speaking, the fund is more sensitive to fluctuations in interest rates, which results in larger price fluctuation, the longer the average maturity. A portfolio with a shorter average maturity is typically less volatile and sensitive.
Understanding Average Maturity
Debt funds engage in various fixed income or debt instruments, each having varied maturity. The maturity date of a bond shows the particular future date on which an investor receives their principal back, i.e. the borrowed cash is fully repaid.
Average maturity is the weighted average of the fund's debt securities' current maturities. The weights represent the percentage of each security in the portfolio.
Average maturity, which is computed in days, months, or years, aids in determining the average time to maturity of all debt securities owned in a portfolio. For example, a debt fund with an average term of 5 years holds debt instruments that will mature in 5 years on average, while individual assets may have maturities other than 5 years.
Taking into account that some bonds may be repaid before their stated maturity date due to actions like calls or refunding, the average maturity is the time it takes for bonds to reach maturity on average. Shares of a fund will rise or fall in reaction to shifts in interest rates in proportion to the length of its average maturity.
Bond Portfolios and Average Maturity
Bonds of varying maturities are the building blocks of a bond portfolio. The maturity date of one bond in the portfolio may be 15 years in the future while that of another could be 5 years in the future. As the maturity date gets closer, the maturity at issuance will decrease.
For example, a 20-year bond issued in 2015 will have a maturity date in the year 2035. In 202 the bond's maturity term will be shortened to 13 years. If a bond portfolio is not rebalanced to include newer bond issues, its average maturity will decrease over time.
To get the average maturity, we consider the market value of each bond in the portfolio and the probability of each bond being called separately.
This would also take into account the probability of mortgage prepayments within a certain mortgage pool. Let's pretend for the sake of argument that a bond portfolio contains five bonds, each with a different maturity date: 20, 15, 10 and 5 years). These bonds account for 10%, 20%, 20%, 20%, and 30% of the total value of the investment portfolio, respectively. It is possible to compute the portfolio's average effective maturity by using the formula:
Average maturity = 20 x 0.10 + 15 x 0.20 + 10 x 0.20 + 5 x 0.3 = 2.0 + 3.0 + 2.0 + 1.5 = 8.5 years.
The average duration of the bonds in the portfolio is 8.5 years.
Important Notes
It is crucial to know the portfolio's weighted average maturity in order to understand the interest rate risks that portfolio is exposed to. For example, compared to their shorter-maturity competitors, funds with a longer expected duration tend to be more responsive to changes in interest rates.