What Is Weighted Average Remaining Term (WART)?
Weighted Average Remaining Term (WART) is a metric that captures the average time to maturity of a portfolio of asset-backed securities (ABS). The longer the WART, the longer the portfolio’s assets will take to mature, on average.
Also known as the weighted average maturity (WAM), WART is often used in relation to mortgage-backed securities (MBS) but can also be applied to any portfolio of fixed-income securities.
WART is closely related to Weighted Average Loan Age (WALA), which is its inverse.
Key Takeaways
- The Weighted Average Remaining Term (WART) measures the average time to maturity of a fixed-income portfolio.
- Also known as Weighted Average Maturity (WAM), it’s commonly used with mortgage-backed and other asset-backed securities.
- WART helps investors compare alternative investments based on maturity profiles and assesses a portfolio’s interest rate and prepayment risk.
How the Weighted Average Remaining Term (WART) Works
WART offers investors insights into whether the time to maturity of the assets within a portfolio is relatively short or long. For instance, an MBS with underlying mortgages nearing the end of their terms would have a low WART, while those with newer mortgages would have a higher WART. Depending on their risk tolerances and sources of funding, some investors may prefer investments with specific maturities.
To calculate WART for a portfolio, first add together the outstanding balance of the underlying assets and determine the size of each asset relative to that total. Weigh the remaining time to maturity of each asset according to its size. Lastly, add up these weighted times to maturity to determine the portfolio’s WART.
Commonly used in disclosure materials for MBS, WART doesn’t compare two securities but demonstrates the effects of external forces like prepayment on the WART of a security. Investors consider these calculations for comparisons or portfolio construction.
Example of WART
Consider an MBS consisting of four mortgage loans:
- Loan 1: $150,000 remaining principal, 5 years to maturity
- Loan 2: $200,000 remaining principal, 7 years to maturity
- Loan 3: $50,000 remaining principal, 10 years to maturity
- Loan 4: $100,000 remaining principal, 20 years to maturity
The total remaining value is $500,000. To calculate WART:
- Loan 1: 30% of $500,000 * 5 years = 1.5 weighted years
- Loan 2: 40% of $500,000 * 7 years = 2.8 weighted years
- Loan 3: 10% of $500,000 * 10 years = 1.0 weighted years
- Loan 4: 20% of $500,000 * 20 years = 4.0 weighted years
Summing these weighted years gives a WART for the entire portfolio of 1.5 + 2.8 + 1.0 + 4.0 = 9.3 years.
WART and Interest Rate Risk
Generally, fixed-income securities with longer maturities have greater price sensitivity to interest rate changes, known as duration. MBS and ABS with higher WARTs expose portfolios to more interest rate risk than those with smaller WARTs. One strategy to reduce this risk is bond laddering.
Bond laddering involves purchasing bonds with varying maturity dates so that proceeds return at different times, reducing the need to reinvest the portfolio all at once, especially when interest rates are low. This helps maintain a reasonable interest rate on a bond portfolio, assessed using WART.
WART vs. WALA
WART and WALA both estimate the credit risk, interest rate sensitivity, and potential profitability of fixed-income portfolios. While WART measures the average time to maturity for securities in a fixed-income portfolio, WALA is its inverse, focusing on the average time since the securities were issued. Both metrics provide valuable insights for investors.
What Is Prepayment Risk?
Prepayment risk affects MBS and ABS and arises when borrowers refinance or make unscheduled payments, effectively reducing the WART of the portfolio. This is particularly significant during periods of declining interest rates, as refinancing leads to the replacement of original loans with new ones at lower interest rates, altering the risk profile and expected cash flows.
Purpose of Mortgage-Backed Securities (MBS)
MBS pool many mortgages into a single security, which mitigates the risk of any single borrower defaulting. This diversification aims to provide more stable returns while spreading risk.
Difference Between Weighted Average Maturity (WAM) and Weighted Average Life (WAL)
Both WAM and WAL are crucial in evaluating money market funds. WAM considers interest rate resets, whereas WAL does not. Regulatory limits often apply to WAL to ensure financial stability.
Related Terms: Weighted Average Maturity, Weighted Average Loan Age, Prepayment Risk, Interest Rate Risk, Bond Laddering.
References
- Financial Industry Regulatory Authority. “Regulatory Notice - 21-02 - MBA Dissemination - Attachment A”, Page 2.
- Fidelity. “Understanding Money Market and Bond Fund Terminology”.
