When you read up or look into debt mutual funds, there are often a host of terms used. Here’s explaining those bits of jargon so you can understand debt funds better.
Maturity period: A bond’s maturity period is the number of days, weeks, months, or years for which it is issued. Interest is paid at defined intervals during this period. In a 5-year fixed deposit, for example, the maturity period is five years. At the end of the maturity period, the principal and any residual interest will be returned. Depending on the issuing institution and timeframe, these debt instruments have different names. When you see commercial papers (CP), for example, know that they are short-term papers issued by companies. Certificate of deposits (CD) are short-term instruments issued by banks. Treasury bills and gilts are short and long-term instruments issued by the government. Banks and companies both issue long-term bonds. Companies also issue debentures – convertible into equity and non-convertible into equity (or NCDs, as you may have read). Debt mutual funds invest in a combination of these, depending on their type. CBLO are very short-term instruments that funds often use as proxies to cash.
Portfolio maturity: For debt mutual funds, the average of the remaining maturity periods of the papers it holds at that point becomes its average portfolio maturity. It will tell you whether the fund is investing in very short-term, short-term papers or long-term papers. The break-up of the portfolio into CP, CD, treasury bills, gilts, and bonds will tell you what type of fund it is – accrual, dynamic bond, liquid, ultrashort, gilt. As the fund’s portfolio changes, the average maturity will also change but funds (other than dynamic bond funds) more or less move around a particular average maturity.
Coupon rate: The coupon rate or coupon of a bond is the interest rate paid on that bond. However, the coupon rate may or may not be the actual return you can make from that instrument. Move to the next term to understand why.
Yield or yield to maturity: Yield is return. In a debt instrument, yield is the annualised return you will get if you hold that instrument until maturity. This yield considers the interest accrued throughout the term of the bond in exchange for the price paid to buy it. The yield to maturity – shortened to YTM in financial jargon – can be different from the bond’s coupon rate because of the price you pay to invest in it. Remember, bonds are traded on and off the exchanges. One can get into a bond at a different price from its face value. The coupon rate will be different from the YTM when the price paid for the bond is not the issue price. If the bond’s price is higher than the issue price, the YTM will be lower than the coupon. If the bond’s price is below the issue price, the YTM will be higher than the coupon. For example, a 3-year bond with a face value of Rs 100 and an interest rate of 7% will have a YTM of 7.38% if the bond’s price drops to Rs 99. If it rises to Rs 101, the YTM would become 6.62%
Portfolio YTM: The average portfolio yield, or the average of the YTMs in the portfolio. this figure will tell you what the return would be if the fund held all the papers in its portfolio to maturity. It roughly indicates the return you can expect if you held the fund for the period of its average maturity. It’s not guaranteed, because the portfolio itself keeps changing and the fund may sell off some instruments if its prices rally. You could, in such cases, earn more than the portfolio yield. But if a fund predominantly has a buy and hold approach, then the yield is an indicator of what you may earn if you hold the fund over its average maturity period.
Credit rating: Credit rating represents the credit quality of the company. It indicates the company’s ability to meet interest and principal payments on time. A company with high credit quality will have a high degree of safety in paying the interest due and principal repayment and vice versa. For short-term instruments, ratings are usually termed as A1 to A4 from best to worst. In between each grade, there are sub-grades, so to speak, by tagging a ‘+’ or a ‘-’ sign. So, an A1+ is a notch higher than A1, which in turn is one step better than A1-, in turn better than A2+ and so on. Long-term ratings start from AAA at the highest grade to D at the lowest. D in both long-term and short-term ratings indicate that the instrument are in default or expected to move into default soon. Ratings are not constant and are revised from time to time by rating agencies.
Portfolio credit profile: The credit profile of the instruments in the fund’s portfolio will tell you whether it is a fund that holds high-quality papers or one where credit risk is high. High portfolio yields are usually an indicator that the fund holds low credit quality papers, since such papers pay out high coupons.
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