Portfolio or strategy maturity (duration) limits are perhaps the most defining part of short- term strategies. Beyond what the credit research team defines as individual security credit limits, each strategy has maturity limits, determining the amount of time the strategy can be exposed to assets or interest rates. For government and prime strategies, they are specific and prescriptive. For enhanced cash and ultra-short-term strategies they can be more flexible.
Maturity limits are important because they impact risk, liquidity and return. For risk, the longer a strategy holds its investments, the more opportunity there is for conditions to change affecting performance. All other factors being equal, a diverse portfolio of credit maturing in 30 days on average bears less risk than one maturing in 90 days. The shorter portfolio would also be more liquid, given that more of the investments would be maturing soon, reducing the potential need to sell an asset and face market risk. As for return, a portfolio with a longer duration may offer a higher yield, reflecting greater risk. On the other hand, longer duration fixed-rate notes would pose interest rate risk: if interest rates rise, the value of the notes would decline.
Maturity metrics include weighted average maturity, weighted average life and legal final maturity.
Weighted average maturity (WAM) Also known as interest rate duration, WAM is an indicator of a strategy’s sensitivity to interest rate changes. WAM measures the amount of time, measured in days, to the next interest-rate reset, weighted by the size of each asset and averaged. (For fixed-rate notes, the final maturity date is used.) A longer WAM signifies greater interest-rate risk.
Weighted average life (WAL) This measures the strategy’s maturity, in days. In the case of floating-rate debt, WAL uses the final maturity date and not the coupon reset date. WAL is also known as credit duration as it measures when the credit matures out of the portfolio. While extending WAL can help boost returns, WAL is an indicator of credit risk, given that the longer a strategy holds its investments the more chance there is for a credit event.
Legal final maturity (LFM) This measures when a strategy’s bonds must mature to avoid defaulting. Usually this would be the maturity date of the debt. For ABS and other structured debt, the LFM and expected maturity data may differ. Most ABS deals measure their maturity using expected maturity, when the deal will most likely pay off or mature. But this measure varies depending on the speed of the underlying payments. For example, borrowers may pay their auto loans more quickly (or slowly) than expected, impacting the expected maturity of an auto loan ABS. For ABS, the LFM is typically much longer than the expected maturity.
Enhanced cash and ultra-short-term strategies can use the same WAM and WAL measures but don’t necessarily have hard legal final maturity restrictions. This enables portfolio managers to invest in structured debt with expected maturities, capitalizing on a return opportunity.