A reader says, “You discussed money market and arbitrage funds as debt instruments and average maturity values. I could not grasp this concept of average maturity. Google search tells me that avg maturity value of money market funds are like one year. Does this mean I have to withdraw the amount after one year to have the best return? The point of a debt mutual fund was to save tax and only withdraw when necessary, right?”
“Also I don’t know how to figure out the avg maturity for arbitrage funds. I have another question. Why do you insist on investing only these two debt instruments? What’s wrong with Conservative Hybrid funds, for example?”
“Currently I am only investing in nifty index fund for equity. I have some money initially in the Parag Parikh flexi fund, but I plan not to invest in any fund other than index funds. I have three index funds to keep track of three goals following the independent portfolio approach from your robo tool. Does this look good to you?”
Average Maturity is the weighted average of all the current maturities of the bonds held in a fund. For example, If a fund holds Rs. 2 Cr of 1Y bonds and Rs. 3 Cr of 4Y bonds and Rs. 7 Cr of 15-year bonds, the average maturity is:
[(2×1) + (3 x 4) + (7 x 15)] divided by the total AUM (2+ 3 + 7)
In open-ended funds, when old bonds mature, new bonds are added. If the new bonds have the same maturity as that of the old bonds, the average maturity will not change much.
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In the bond market, the longer the bond tenure, the more the price will fluctuate due to supply and demand forces that speculate future interest rates. Therefore, the average maturity of a fund is an excellent indicator of interest rate sensitivity (the only exception is when the fund holds floating-rate bonds).
Liquid funds and money market funds have low interest rate sensitivity as they hold bonds that mature within a few months to a year. So, such funds can be used for short-term goals or drawing income after retirement.
A useful rule of thumb is to buy a fund with an average maturity of X/2 or X/3 if you need the money after X years. So if you want the money in a year, a liquid fund that hold bonds for no more than 90 days will work. A money market fund that can invest in bonds that mature up to a year can be use if you want the money 2-3 years (or more). This will keep NAV volatility at bay at all times.
If a mutual fund has an average maturity of 1Y, should I redeem after 1Y? Certainly not. The two are unrelated except by the above rule of thumb.
Yes, even though debt fund gains are taxed as per slab, they are still tax efficient compared to FDs because you make partial withdrawals whenever you need.
How to figure out the avg maturity for arbitrage funds? These are usually a few months. You can get the data from our monthly debt fund and hybrid fund screeners.
Why do you insist on investing only these two debt instruments (money market and arbitrage)? What’s wrong with Conservative Hybrid funds, for example?
For long term goals, I have also recommended gilt funds and corporate bond funds. I have also recommended (and invested in) the Parage Parikh Conservative Hybrid Fund. See Plumbline: Select Mutual Funds. And: What debt fund should I add to a long term investment portfolio?
Fund Choices: We do not offer opinions on individual fund choices. In general, using index funds is ideal, provided you are convinced to hold on to them without worrying about active fund performance.
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