For investors looking forward to putting their money in debt mutual funds, short-term income funds present a suitable option. Such funds invest in debt and money market securities with a portfolio duration of 1-3 years.
The portfolio duration of these schemes is determined by the Macaulay duration. So, what exactly is the Macaulay duration?
Simply put, the Macaulay duration of a bond is a measure of how long an investor must hold onto debt securities to get back all the invested money by way of periodic interest and principal repayments. It is measured in units of years.
So, the Macaulay duration calculates the weighted average time to receive the cash flows from debt security. The cash flows include the periodic interest or coupon rates, and the maturity amount or the sale proceeds, in case if sold before maturity.
The weight of each cash flow is considered by dividing the present value of the cash flow by the debt security price. When multiplied by the duration of the cash flow, it provides the weighted duration of each cash flow. After it is summed up, these weighted durations provide the Macaulay duration of a debt fund.
By gaining insight into the Macaulay duration of a debt fund portfolio, an investor can understand the price sensitivity of the debt fund portfolio to interest rate risk and match investments as per the risk appetite and financial goals in the long run.
It is, therefore, essential to look into duration before an investor plans to leap into debt fund investing.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.