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Debt schemes and concept of portfolio yield to maturity

The returns you actually earn from the debt scheme may or may not be similar to the Portfolio YTM

Bekxy Kuriakose

Whether you are an existing debt scheme investor or a new investor looking to invest, there are few basic concepts about debt schemes of mutual funds that you should be aware of. Portfolio YTM (Yield to Maturity) being one of them. No don’t shut away this article! It’s not so complex or difficult to understand! And looking at the YTM can help to give you a generalized sense of interest rates and expected returns.

To begin with the definition of YTM. To understand that we must first understand the basic nature of a typical debt security. Any debt instrument like debentures, bonds etc. have a price at which it can be bought today. It also has a redemption /maturity value and the debt instrument may or may not have intermediate cash flows or coupon payments depending on whether its coupon bearing or not.

Debt securities which don’t have coupon in between are typically zero coupon bonds. The YTM in a simplified sense is nothing but the rate of return earned by the investor today at the price at which the security is bought after accounting for all the cash flows of the bond (coupon payments and redemption payment and assumes these payments are done on time). This formula also assumes that the debt security would be held till maturity.

Usually when the bond is issued for the first time in the primary market at par (Rs 100) the coupon rate of the bond equals the YTM. Subsequently the bond may trade above par or below par depending on movement in interest rates. Just like stock prices move on a daily basis, in the debt market interest rates also move on daily basis.

So a bond’s price may keep changing post issuance. Depending on whether the bond trades above par or below par its YTM maybe lower or higher than the coupon rate set initially. In the Indian debt market the YTM is usually expressed as an annualized yield for most debt securities except government bonds (expressed as semi-annual yield).

Once the YTM for each security is available, the Portfolio YTM can be calculated as the weighted average (market value of securities held) of the YTM of each security to the Total AUM of the debt fund. This number is expressed as a percentage.

YTM of shorter dated debt securities is lower than those of longer dated securities (but may not always be the case). YTM of sovereign debt securities like government bonds is usually lower than those of non-sovereign or corporate debt securities of same tenor. And YTM keeps changing on a daily basis. Regardless, the Portfolio YTM is a fair indicator of the overall interest rates prevailing in the debt market at any point in time. Considered together with the Portfolio Average Maturity it gives a fair sense of the gross returns that an investor can expect over similar holding period for his/her investments.

However it is pertinent to remember that the returns you actually earn from the debt scheme may or may not be similar to the Portfolio YTM. This is especially true of actively managed open ended debt funds where fund manager may change the securities thereby altering the Portfolio average maturity and YTM based on his/her interest rate view and market conditions. This can lead to capital gains or losses which can add or reduce the portfolio returns. The Gross Portfolio YTM is published on a monthly basis in the factsheets released by mutual funds. To summarise the concept of YTM.

1.Portfolio YTM gives a sense of overall interest rates prevalent in the debt market and returns that an investor can expect over a return horizon similar to portfolio average maturity.

2.Portfolio YTM can change frequently as securities are bought or sold in the portfolio and is a function of daily movements in interest rates.

3.Returns from a debt fund is a function of not just YTM but also capital gains and losses.

Author is Head – Fixed Income, Principal Pnb Asset Management Company

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol are their own and not that of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.

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