What is Weighted Average Maturity (WAM)?
Weighted Average Maturity (WAM) represents the average period until the maturities on mortgages in a mortgage-backed security (MBS) or other portfolios of debt securities such as corporate debt and municipal bonds. This financial metric is crucial for managing and evaluating the performance of debt portfolios.
WAM intricately ties to another metric known as Weighted Average Loan Age (WALA).
Key Takeaways
- Weighted Average Maturity (WAM) reflects the maturation period of pooled mortgages in an MBS.
- Portfolios with higher WAMs entail greater interest rate and credit risk compared to those with shorter WAMs.
- WAM contrasts with WALA, determining the average life of a loan within the portfolio.
The Power Behind Weighted Average Maturity
Calculating WAM involves assessing the percentage value of each mortgage or debt instrument in your financial portfolio. Multiply the number of months or years until the bond’s maturity by each debt instrument’s percentage. The total sum provides the comprehensive weighted average maturity for the portfolio.
WAM serves as a strategic tool for managing bond portfolios and gauging a portfolio manager’s performance. For instance, mutual funds offer bond portfolios with varied guidelines regarding WAM. Investors have the leeway to select bond funds aligning with their investment timelines. The performance index of such a fund also serves as a benchmark against which investment performance is measured.
Bond laddering, an essential investment strategy, involves holding bonds with staggered maturity dates. This methodology ensures steady reinvestment and capital return over time, mitigating risks associated with low rates at the time of reinvestment. Income-focused investors often leverage WAM to appraise their portfolio’s resilience.
An Enhanced Example of Calculating WAM
Consider an investor who owns a $30,000 bond portfolio, comprised of different bonds:
- Bond A: Valued at $5,000 (16.7% of the total portfolio) with a maturity period of 10 years.
- Bond B: Valued at $10,000 (33.3% of the portfolio) maturing in 6 years.
- Bond C: Valued at $15,000 (50% of the portfolio) with a 4-year maturity.
To ascertain the WAM:
(16.7% * 10 years) + (33.3% * 6 years) + (50% * 4 years) = 5.67 years or approximately 5 years and 8 months.
Comparing Weighted Average Maturity and Weighted Average Loan Age
Though both WAM and Weighted Average Loan Age (WALA) are pivotal for evaluating mortgage-backed security profitability, WAM presents a more comprehensive measure. WAM quantifies the maturation period for pooled securities in your portfolio weighed against the invested amounts. A portfolio endowed with a higher WAM accentuates increased sensitivity to interest rate fluctuations.
Conversely, WALA can be viewed as the reverse of WAM. The earlier the investment ages, the lesser the time to reach maturity, reflecting in the weighted age calculation, reinforcing the sophistication of debt portfolio evaluation mechanisms.
Related Terms: weighted average loan age (WALA), mortgage-backed security (MBS), bond laddering, maturity, mutual funds
References
- Financial Industry Regulatory Authority. “Regulatory Notice - 21-02 - MBA Dissemination - Attachment A”, Page 2.
- Janus Henderson Investors. “Q1 Fact Sheet”, Page 2.
- Fidelity. “Understanding Money Market and Bond Fund Terminology”.
- Morgan Stanley. “Short Duration Income Portfolio”.
- Charles Schwab Corporation. “Bond Ladders”.
