Understanding Terms in a Mutual Fund Factsheet-II

In my last article I wrote  about the terms used in a factsheet for equity mutual funds. It might have been easier to understand those terms but when it comes to debt market many of us lack knowledge of understanding even the basics and so avoid it. The mutual fund factsheet makes it easier by giving information on some terms which are helpful in analyzing a  debt mutual funds scheme.

Here I am giving a brief about the terms used in debt mutual funds and what they mean to an investor:

1. Average Maturity-This is one of the important factors for the investors. A debt mutual fund invests in various fixed income or securities which will have different maturities. The maturity of any security is the period when the investor gets its principal back along with any due interest. An average maturity denotes the weighted average of all the securities in the portfolio .i.e. the average time to maturity of all the securities held in the portfolio. So a 6 years average maturity will signify that that most securities in the portfolio will mature in 6 years although individually they may have different time period. The average maturity tells you the sensitivity of the portfolio w.r.t. interest rates. Since the long term securities are more sensitive to interest rates, any debt mutual fund scheme with higher average maturity of the scheme will be more prone to fluctuations with change in interest rates. Generally you will find long term funds such as income and gilt with higher average maturity then short term funds such as liquid. So by looking at this factor one can identify the interest rate risk in the scheme.

2. Modified Duration– A Duration assesses price sensitivity of the fixed income security with respect to interest i.e. how much the security prices gets affected when interest rates moves up and down. Modified Duration is an advanced concept which tells you how much the price of a fixed income security will move if the interest rate moves by 1%. The movement is calculated (in %) by multiplying the modified duration with % change in the interest rate. So if the modified duration is 10 years, the price of the security will move up by 10% if interest rate go down by 1% and vice versa. This analysis is important for the investors to compare the interest rate risk of one fund with another. Also it can give a view of the fund manager with regards to interest rates movement. However, this is one of the factors and should be used in conjugation with other factors like credit quality etc. which affect fixed income security prices.

3. Yield to Maturity– This indicates the yield which is generated from the portfolio if the securities are held till maturity. It takes into consideration the coupon payments and the market price of the security during the period. A YTM of any scheme will indicate the possible returns which will be generated if it is held till maturity. However, in no way it signifies the historical returns or future returns from the portfolio because a fund manager may make changes in the portfolio based on interest rates views and other factors. But by looking at this factor the near possible returns from the portfolio where there may not be heavy changes can be assessed.

These are most common factors for analyzing  debt mutual fund schemes and are mentioned in a factsheet. By using these investors are in a good position to identify various debt schemes which can match their risk appetite. But before making any decisions, its wiser to consider other factors also which can affect securities in a debt market .