YTM: Know all about yield to maturity

Two friends met over lunch and soon the conversation veered towards investing, and specifically the concept of yield to maturity.

Maharshi: Hey! I have been hearing in the news in recent times that short-term, medium-term and long-term debt instruments currently offer similar yield-to-maturity. I am getting confused. So what does this mean? I have read that yield means returns, so should I believe that they will be giving me same returns?

Darshan: No! It’s not exactly true. Basically, YTM shows the indicative return.

Maharshi: Can you please elaborate?

Darshan: Yield-to-maturity, as the term suggests, is the yield i.e., the return you can earn on a bond or other debt instrument if you hold it till maturity. This is so because, on maturity, you get the exact par value quoted initially by the bond. If you sell it earlier, you may or may not be able to get exactly the same redemption proceeds as bonds too, like stocks, are being traded in the market day in and day out.

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Maharshi: Okay. So that may also mean that YTM may be different for me investing today compared to the person investing tomorrow, right?

Darshan: Yes. If you buy a bond tomorrow rather than today, YTM might be lower than that what you are getting today. This is because, for the same coupon amount, you are paying a higher price. So effectively, lower returns for you. For each person investing in the same security at different points in time, YTM might vary due to factors such as changes in interest rate, bond ratings and inflation.

Maharshi: Understood. So, extending your logic, you are saying that if I hold any debt fund till a specific period, I can get the exact returns as the YTM mentioned in its factsheet?

Darshan: No. See, the ballgame works different for debt funds. Firstly, they aren’t holding one bond or one debt instrument. They are holding many securities. So, here the YTM of debt fund is the weighted average YTM of all such bonds. Another point is, in the case of most open-ended debt mutual funds, there is every possibility that you may get return different from that of YTM irrespective of the period you hold the fund. This is because there could be inflow, outflow of funds from the portfolio. Also, there could be churn in portfolio if the fund manager tries to get the benefit of changing interest rates.

However, do note that you might get returns similar to YTM in case of target maturity funds and some closed-ended funds such as fixed maturity plans and interval funds.

Maharshi: Got it. Thanks for the explanation. I’ll use these inputs to select debt funds.

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