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Weighted Average Remaining Term (WART)

Weighted Average Remaining Term (WART)
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What Is the Weighted Average Remaining Term (WART)?

Weighted Average Remaining Term (WART) is a metric that catches the average chance 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.

Otherwise called the weighted average maturity (WAM), WART is many times utilized comparable to mortgage-backed securities (MBS) however can likewise be applied to any portfolio of fixed-income securities.

WART is closely connected with weighted average loan age (WALA), which is its inverse.

How the Weighted Average Remaining Term (WART) Works

The WART of a portfolio is a useful metric since it assists investors with understanding whether the time to maturity of the assets inside the portfolio is relatively short or long. For example, a MBS whose underlying mortgages are exceptionally close to the furthest limit of their terms would have a low overall WART, while one with mortgages that have as of late been initiated would have a higher WART. Contingent upon their risk resistances and sources of funding, a few investors might favor being presented to investments with a specific opportunity to maturity.

To work out the WART of a portfolio, the investor first includes the outstanding balance of the underlying assets and computes the size of every asset corresponding to that total. Then, at that point, the investor would gauge the leftover chance to maturity of every asset by utilizing every asset's relative size. As a last step, they would then include the weighted times to maturity of every asset to show up at a WART for the whole portfolio.

WART is ordinarily utilized in the disclosure materials associated with MBS, for example, those offered by Freddie Mac. In this unique situation, WART serves not to compare two securities but rather to demonstrate the effects of outside powers like prepayment on the WART of the security. An investor considering a Freddie Mac security would consider these WART calculations while contrasting it with an alternative investment or while seeking to build a portfolio containing various WARTs.

Illustration of WART

To illustrate, consider a MBS comprising of four mortgage loans, in which loan 1 has $150,000 of residual principal due in 5 years, loan 2 has $200,000 due in 7 years, loan 3 has $50,000 due in 10 years, and loan 4 has $100,000 due in 20 years. The total leftover value of the loans is thusly $500,000.

To work out the WART, our next step is compute each mortgage's share of the total excess value. By separating each mortgage's leftover principal by the $500,000 total, we would find that loan 1 addresses 30% of the total, loan 2 addresses 40%, loan 3 addresses 10%, and loan 4 addresses 20%.

We can then work out the weighted excess term of each mortgage by duplicating its chance to maturity by its share of the $500,000 total. In doing as such, we track down the following weighted leftover terms:

  • Loan 1: 5 years x 30% = 1.5 weighted years
  • Loan 2: 7 years x 40% = 2.8 weighted years
  • Loan 3: 10 years x 10% = 1 weighted years
  • Loan 4: 20 years x 20% = 4 weighted years

Our last step is to just add these weighted years together, to show up at a WART for the whole portfolio. In this case, our WART is: 1.5 + 2.8 + 1 + 4 = 9.3 years.

WART and Interest Rate Risk

As a general rule, bonds and other fixed-income securities with longer maturities have greater price sensitivity to interest rate changes than shorter maturity securities (known as the security's duration). MBS and ABS with bigger WARTs, in this manner, that's what hold bonds, on average, will have more interest rate risk than those with more modest WARTs.

One method for lessening this type of risk is through laddering. Bond laddering is an investment strategy that includes purchasing bonds with various maturity dates, and that means that the dollars in the portfolio are returned to the investor at various points after some time. A laddering strategy allows the owner to reinvest bond maturity proceeds at current interest rates over the long haul, which reduces the risk of reinvesting the whole portfolio when interest rates are low. Bond laddering helps an income-situated investor keep a reasonable interest rate on a bond portfolio, and these investors use WART to survey the portfolio.

WART versus WALA

Weighted average excess term (WART) and weighted average loan age (WALA) are both used to estimate the credit risk, interest rate sensitivity, and possible profitability of fixed-income portfolios. WAM will in general be involved measure for the maturity of pools of mortgage-backed securities (MBS). It measures the amount of time for the securities in a fixed-income portfolio to mature, weighted in relation to the dollar amount invested. Portfolios with higher WARTs are more sensitive to interest rate changes.

WALA is basically the inverse of WART: The number of months or years until the bond's maturity is duplicated by every percentage, and the sum of the subtotals equals the weighted average maturity of the bonds in the portfolio.

Features

  • The weighted average excess term (WART) is a measure of the average opportunity to maturity of a fixed-income portfolio.
  • WART is especially important in surveying a portfolio's interest rate and prepayment risk exposures.
  • WART is otherwise called weighted average maturity, or WAM.
  • A few investors might favor having exposure to investments with specific maturity profiles, making WART a supportive instrument for contrasting alternative investments.
  • It is much of the time utilized corresponding to mortgage-backed securities (MBS) and other asset-backed securities (ABS), despite the fact that it tends to be applied to any fixed-income portfolio.

FAQ

What Is the Difference Between Weighted Average Maturity (WAM) and Weighted Average Life (WAL)?

WAM and WAL are basically utilized while assessing money market funds. The difference among WAM and WAL is that WAM considers interest rate resets and WAL doesn't. The SEC limits the WAL for money market mutual funds to 120 days.

What Is Prepayment Risk?

Prepayment risk applies to MBS and ABS and is the reduction of the asset's WART due to homeowners or different borrowers refinancing their loans or making early unscheduled payments. These repayments effectively shorten the average maturity of a portfolio and change its risk profile. This is particularly a risk in an environment of declining interest rates. As mortgages, for instance, are renegotiated, the original loans are totally paid off and supplanted with a new, lower-interest rate loan. Funds holding MBS with the original mortgage will never again receive cash flows from that homeowner.

What Is the Purpose of a Mortgage-Backed Security (MBS)?

Mortgage-backed securities (MBS) effectively take a pool of many mortgages and package them together into a single security. The thought is that while any single home loan might have idiosyncratic risk that the borrower will default, a portfolio of many mortgages would quiet the effect of any single terrible loan.