Understand Average Maturity.

In the case of an individual bond, Maturity refers to the time period after which the initial investment, i.e., the Principal, is repaid by the Bond Issuer to the Bond Holder. Debt Mutual Funds invest in multiple bonds with different maturities. So to calculate the Average Maturity of a Debt Fund, you have to use the weighted average method to determine how much time it will take for all the bonds in the fund’s portfolio to mature. The weights are the percentage holding of each security in the portfolio.

Average maturity is the weighted average of all the current maturities of the debt securities held in the debt fund.

2. How to Calculate Average Maturity?

For example, suppose a debt fund is invested in 3 bonds with face values of rs. 1000, rs. 3000, and rs. 5000. if the time to maturity for these bonds is 3 years, 4 years, and 5 years respectively, the average maturity calculation of the debt fund will look like this:

Debt Fund Average Maturity Calculation Example
Bond Name	Bond 1	Bond 2	Bond 3
Face Value (FV)	₹1000	₹3000	₹5000
Time to Maturity	3 years	4 years	5 years
Weighted Total (WT)	3000	12,000	25,000
Average Maturity of Debt Fund	4.4 years

 

In the above table, the Average Maturity of the Debt Fund portfolio = (WT of Bond 1 + WT of Bond 2 + WT of Bond 3) / (FV of Bond 1 + FV of Bond 2 + FV of Bond 3) = (3000+12000+25000) / (1000+3000+5000) = 4.4 years.

Average Maturity’s Impact on Volatility in Debt Funds  

The main use of Average Maturity is to determine the Interest Rate sensitivity of a Debt Fund. The simple rule is that Debt Funds with higher Average Maturity are more susceptible to changes in Interest Rates as compared to Debt Funds with lower Average Maturity. The below table shows the Average Maturity and Interest Rate Sensitivity of various Debt Fund Benchmarks:

Average Maturity vs. Interest Rate Sensitivity of Different Debt Fund Benchmarks
Benchmark	Average Maturity (Years)	Interest Rate Sensitivity
Overnight Index	0	Very Low
Liquid Fund Index	0.1	Very Low
Money Market Index	0.3	Low
Ultra Short-Term Debt Index	0.4	Low
Low Duration Debt Index	0.7	Low
Short-Term Bond Fund Index	2.2	Moderate
Composite Credit Risk Index	4	Moderate
Banking and PSU Debt Index	4.1	Moderate
Medium-Term Debt Index	4.2	Moderate
Corporate Bond Index	5.3	Moderate
Dynamic Debt Index	7.6	High
Medium-Long Term Debt Index	8.4	High
10-Year Gilt Index	9.8	High
Composite Gilt Index	10.4	High
Long-Term Debt Index	14.2	Very High

 

In the above table, you can see that categories such as Overnight, Liquid, and Ultra Short Term Funds have the shortest Average Maturity. This indicates that these schemes are least impacted by Interest Rate changes. On the other hand, Long Duration and Gilt categories have the longest Average Maturities, which makes them highly susceptible to changes in Interest Rates.

 

Using Average Maturity while Shortlisting Debt Funds

The Average Maturity of Debt Funds is directly linked to the Interest Rate sensitivity of a debt scheme. The higher the Average Maturity of a Debt Fund, the higher its interest rate sensitivity, and a low Average Maturity indicates low sensitivity to Interest Rates. However, as Interest Rate changes and Bond prices are inversely correlated, i.e., lower Interest Rates lead to higher Bond prices, Debt Mutual Funds with high-Interest Rate sensitivity can prove to be very lucrative investments when Interest Rates fall. To understand this, take a look at the returns data of two long-maturity funds – SBI Gilt Fund and ICICI Prudential Long Term Bond Fund during periods of Interest Rate Changes by the Reserve Bank of India (RBI):

Interest Rate Change Vs. Returns of Long-Duration Funds Across Various Time Periods
Time Period	RBI Rate Change	SBI Gilt Fund Returns	ICICI Prudential Long-Term Bond Fund Returns
Jan 2006 – Jul 2008	2.75%	4.70%	5.70%
Jul 2008 – Jan 2009	-3.50%	43.00%	71.20%
Jan 2009 – Nov 2011	3.00%	-2.60%	2.50%
Nov 2011 – Jun 2013	-1.25%	16.60%	14.50%
Jun 2013 – Feb 2015	0.50%	11.00%	6.40%
Feb 2015 – Aug 2017	-1.75%	10.10%	9.50%
Aug 2017 – Aug 2018	0.50%	-0.60%	-0.10%
Aug 2018 – Feb 2021	-2.50%	10.90%	9.8%

 

In the above table, you can see that both of these schemes have posted significantly high returns during periods when RBI has decreased Interest Rates. This is the basis of the Duration Strategy in Debt Funds. This strategy can deliver significantly high returns for the investor if a fall in Interest Rates is predicted accurately. You might also have noticed that the opposite happened when RBI increased Interest Rates i.e. both the schemes underperformed. This is due to their higher Interest Rate Sensitivity and the inverse relationship between Bond Prices and Interest Rates, i.e., an increase in Interest Rates leading to lower Bond Prices. So, one way in which you can minimize the impact of rising Interest Rates on Your Debt Portfolio is to increase your investments in Debt Funds with low Average Maturity. This way, using the relationship between Average Maturity and Interest Rate Sensitivity, you can determine the best way to actively manage your Debt Investments to balance the overall risk and return in your portfolio.