Here's How Yield To Maturity Affects Your Debt Fund Returns
Investors should know the exact meaning of YTM as it will them choose which debt investment to make.
A term called "yield-to-maturity" often crops up when dealing with debt-oriented funds and other traded debt securities like government securities and bonds.
It is important for the investor to know the exact meaning of the term and what it means, as this will help them choose which debt investment to make.
Investors should also not give a wrong meaning to this, as otherwise, they will have expectations that might not turn out to be correct and lead to a different outcome at the end of the day.
Yield-to-maturity, also known as YTM, refers to the earnings that an instrument or a portfolio of debt securities will have if the security or the portfolio is held until its maturity.
Since the returns on a debt instrument consist of both the coupon rate and a capital gain or loss at the time of maturity, it is not easy to just look at an instrument and then know the return that it will generate. The situation is also made more complicated by the fact that different instruments mature at different times.
This is why there is a need to ensure that there is a measure that will give an easy understanding of the return, and this is what the YTM does.
Only For Maturity
The main point of the YTM figure is that it shows the return that the investor will earn if the instrument is held until maturity.
The debt instruments are also traded on the secondary market, just like equity shares are traded on a stock exchange, so there will be price changes that will be witnessed in a debt instrument, and this will change the YTM. It could be that the return that the investor sees on the investment is even higher than the YTM that they saw when they bought the investment. This can happen because the changes in the debt investment depend on the interest rates in the economy, so a fall here will push up the returns in the intermediate period.
Similarly, the returns can also fall in the intermediate period, but they will come back to the YTM if it is held till maturity.
Matching With The Fund
Investing after looking at YTM for different types of debt funds will have varying implications.
For example, if an investor buys a target maturity fund and then invests at a specific YTM, they will get this return if they hold the fund till maturity. Here, the fund will actually close its operations, as this is a close-ended fund.
However, when it comes to an open-ended fund, the YTM will be applicable only until the existing instruments in the portfolio mature. As the old instruments mature and are replaced by new ones in an open-ended fund, the YTM will also keep changing. In a fund with a shorter duration, like a liquid fund or an ultra short-term fund, portfolio changes will be frequent as the old instruments keep maturing at very short intervals and are replaced with new ones.
Indication Of The Road Ahead
The YTM keeps changing regularly, as this figure is impacted when the price changes or the instrument changes in the portfolio. This is why the investor must consider the YTM at the time of investment as well as the nature of the fund to determine what they should do.
For example, if the YTM of an open-ended medium-term fund has fallen quite a bit, investors know that the returns are not going to be great, and they should temper their expectations accordingly. The period of maturity of the instruments in the fund will also give an indication of the period for which the existing YTM will be in play.
Arnav Pandya is founder of Moneyeduschool