Table of Contents
- What Is Weighted Average Maturity (WAM)?
- Key Takeaways on WAM
- Understanding Weighted Average Maturity
- Tip on Bond Laddering
- Example of How WAM Is Computed
- Weighted Average Maturity vs. Weighted Average Loan Age
- What Is a Mortgage-Backed Security?
- How Is Weighted Average Maturity Different From Weighted Average Loan Age?
- What Is the Purpose of Weighted Average Maturity?
- The Bottom Line
What Is Weighted Average Maturity (WAM)?
Let me explain weighted average maturity (WAM) directly to you: it's the weighted average time until the mortgages in a mortgage-backed security (MBS) reach maturity. I use this term more broadly for maturities in any debt securities portfolio, including corporate debt and municipal bonds. If the WAM is higher, it means it takes longer for all the mortgages or bonds in that portfolio to mature. You should know that WAM helps manage debt portfolios and evaluate how well debt portfolio managers are performing.
WAM connects closely to weighted average loan age (WALA), and I'll cover that relationship later.
Key Takeaways on WAM
Here's what you need to grasp: WAM measures the overall maturity of mortgages pooled in an MBS. A longer WAM means somewhat higher interest rate and credit risk compared to MBS with shorter WAMs. Remember, WAM is the inverse of another key MBS metric, weighted average loan age (WALA).
Understanding Weighted Average Maturity
To compute WAM, I calculate the percentage value of each mortgage or debt instrument in the portfolio. Then, multiply the months or years until maturity by each percentage, and sum those up to get the weighted average maturity of the bonds.
You can use WAM as a tool to manage bond portfolios and assess portfolio managers' performance. For instance, mutual funds offer bond portfolios with various WAM guidelines, ranging from as short as five years to as long as 30 years. As an investor, you pick a bond fund that fits your specific time frame. The fund's objective includes a benchmark like a bond index, and you can check that benchmark's WAM. Managers get judged on the rate of return and the WAM of the fund's bond portfolio.
Tip on Bond Laddering
Consider bond laddering: it's a strategy where you buy bonds with different maturity dates, so your portfolio dollars return at various times. This lets you reinvest proceeds at current interest rates gradually, reducing the risk of dumping everything back in when rates are low. If you're focused on income, bond laddering helps maintain a solid interest rate on your portfolio, and you can use WAM to evaluate it.
Example of How WAM Is Computed
Suppose you have a $30,000 portfolio with three bond holdings. Bond A is $5,000 (16.7% of the total) maturing in 10 years. Bond B is $10,000 (33.3%) maturing in six years. Bond C is $15,000 (50%) maturing in four years.
To find WAM, multiply each percentage by the years to maturity: (16.7% x 10) + (33.3% x 6) + (50% x 4) = 5.67 years, which is about five years and eight months.
Weighted Average Maturity vs. Weighted Average Loan Age
Both WAM and weighted average loan age (WALA) help estimate if an MBS investment will be profitable. But WAM is more commonly used for maturity in pools of mortgage-backed securities. It measures the average time for securities in a debt portfolio to mature, weighted by the dollar amount invested. Portfolios with higher WAM are more sensitive to interest rate changes.
WALA is the inverse of WAM. You calculate it by multiplying the initial value of each mortgage by the months since origination.
What Is a Mortgage-Backed Security?
A mortgage-backed security (MBS) is simply a pool of mortgages bundled and sold as an investment. When you buy shares, you get payments similar to bonds.
How Is Weighted Average Maturity Different From Weighted Average Loan Age?
As I mentioned, WALA is the inverse of WAM. It's computed by multiplying each mortgage's initial value by the months since the loan started.
What Is the Purpose of Weighted Average Maturity?
WAM estimates the profitability of an MBS investment. By knowing the WAM, you can choose a fund that matches your desired time frame.
The Bottom Line
Weighted average maturity measures the time before securities in a portfolio mature, proportional to the investment amounts. A shorter WAM usually means less risk and lower interest rates. Its inverse is weighted average loan age.
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