scorecardresearchDebt fund investments: What role does yield to maturity play in choosing one?

Debt fund investments: What role does yield to maturity play in choosing one?

Updated: 08 Jan 2023, 10:19 AM IST
TL;DR.
A debt fund's YTM does more than just show you an estimate of the possible returns on your investment. Therefore, having a thorough grasp of YTM can help you decide if a certain debt fund is a wise investment for you.
A debt fund's YTM does more than just show you an estimate of the possible returns on your investment.

A debt fund's YTM does more than just show you an estimate of the possible returns on your investment.

A debt fund is a type of mutual fund that invests in fixed-income assets that have the potential for capital growth, such as corporate and government bonds, corporate debt securities, and money market instruments. Debt funds are also known as fixed income funds or bond funds. When choosing a debt fund to invest in, yield to maturity is an important factor to consider.

Yield to maturity, or YTM, is the total anticipated return on investment for a bond if it is held to maturity. YTM takes into account the entire present worth of future earnings from an asset compared to its current market value. Or, to put it another way, it is the internal rate of return of a bond investment, providing the investor holds the bond to maturity, gets all scheduled payments, and reinvests at the exact rate.

Importance of YTM in debt funds

Yield to maturity is a measure of returns for debt funds, however, it is always changing due to shifting market conditions. In practice, the YTM of an open-ended debt fund frequently deviates from the scheme's actual returns.

A change in one bond's YTM will affect the YTM of the debt fund as a whole because debt funds invest in a variety of bonds. The weighting of each bond in the debt fund's portfolio will, however, determine how much of this YTM movement will be reflected in the fund.

Additionally, you may estimate the possible rewards as well as the risk connected with your investment by looking at the YTM of a debt fund. A debt fund with a high YTM often contains significant investments in low-quality bonds or bonds with a low credit rating. In comparison to bonds with higher credit ratings, these low-quality bonds have higher coupon rates, which should, in theory, result in larger profits for investors.

As a result, while investors with a high tolerance for risk may think about investing in debt funds with high YTM to possibly earn large returns, investors with a lower risk tolerance will do better by choosing debt funds with lower YTM that invest primarily in good-quality bonds.

Summing up

A debt fund's YTM does more than just show you an estimate of the possible returns on your investment. It may also serve as a sign of the liquidity and credit risks connected to the debt fund. Therefore, having a thorough grasp of YTM can help you decide if a certain debt fund is a wise investment for you.

However, YTM alone does not provide you with a clear picture of a debt fund's risk profile, and you must also take into account other factors like average maturity and modified duration to fully understand the risks related to your debt investments.

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First Published: 08 Jan 2023, 10:19 AM IST