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Weighted Average Remaining Term WART Meaning Example

Weighted Average Remaining Term WART Meaning Example

Weighted Average Remaining Term (WART): Meaning, Example

Ariel Courage is an experienced editor, researcher, and former fact-checker. She has edited and fact-checked for leading finance publications such as The Motley Fool and Passport to Wall Street.

What Is the Weighted Average Remaining Term (WART)?

The Weighted Average Remaining Term (WART) is a metric that captures the average time to maturity of a portfolio of asset-backed securities (ABS). The longer the WART, the longer it takes for the portfolio’s assets to mature, on average.

Also known as the weighted average maturity (WAM), WART is often used in relation to mortgage-backed securities (MBS) but can also be applied to any portfolio of fixed-income securities.

WART is closely related to weighted average loan age (WALA), which is its inverse.

Key Takeaways

  • The WART is a measure of the average time to maturity of a fixed-income portfolio.
  • It is also known as the weighted average maturity, or WAM.
  • It is often used in relation to mortgage-backed securities (MBS) and other asset-backed securities (ABS), but can be applied to any fixed-income portfolio.
  • Investors may prefer investments with specific maturity profiles, making WART a helpful tool for comparing alternatives.
  • WART is important for assessing a portfolio’s interest rate and prepayment risk exposures.

How the WART Works

The WART helps investors understand whether the assets within a portfolio have a relatively short or long time to maturity. For example, an MBS with mortgages nearing the end of their terms would have a low overall WART, while one with recently initiated mortgages would have a higher WART. Depending on their risk tolerances and funding sources, some investors may prefer investments with a particular time to maturity.

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To calculate the WART of a portfolio, the investor adds the outstanding balance of the underlying assets and calculates the size of each asset relative to that total. Then, the investor weighs the remaining time to maturity of each asset based on its size. Finally, they sum the weighted times to maturity of each asset to determine the WART for the entire portfolio.

WART is commonly used in the disclosure materials of MBS, such as those offered by Freddie Mac. It enables investors to assess the effects of external forces, such as prepayment, on the WART of the security. When considering a Freddie Mac security, investors may compare its WART to that of alternative investments or use different WARTs when constructing a portfolio.

Example of WART

For example, consider an MBS consisting of four mortgage loans: loan 1 has $150,000 remaining principal due in five years, loan 2 has $200,000 due in seven years, loan 3 has $50,000 due in 10 years, and loan 4 has $100,000 due in 20 years. The total remaining value of the loans is $500,000.

To calculate the WART, we calculate each mortgage’s share of the total remaining value. By dividing each mortgage’s remaining principal by the total, we find that loan 1 represents 30%, loan 2 represents 40%, loan 3 represents 10%, and loan 4 represents 20%.

We then calculate the weighted remaining term of each mortgage by multiplying its time to maturity by its share of the total. This yields the following weighted remaining 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 year
  • Loan 4: 20 years x 20% = 4 weighted years
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Adding these weighted years together gives us a WART of 9.3 years for the entire portfolio.

WART and Interest Rate Risk

Bonds and other fixed-income securities with longer maturities are more sensitive to interest rate changes than shorter-maturity securities (known as duration). MBS and ABS with larger WARTs hold bonds that, on average, have more interest rate risk than those with smaller WARTs.

One way to reduce this risk is through laddering. Bond laddering involves purchasing bonds with different maturity dates, spreading the return of dollars over time. This strategy allows reinvestment of bond maturity proceeds at current interest rates and reduces the risk of reinvesting the entire portfolio at low rates.

Bond laddering helps income-oriented investors maintain a reasonable interest rate on a bond portfolio, and they use WART to assess the portfolio.

WART vs. WALA

Weighted Average Remaining Term (WART) and Weighted Average Loan Age (WALA) estimate the credit risk, interest rate sensitivity, and potential profitability of fixed-income portfolios. WAM is often used to measure the maturity of pools of mortgage-backed securities (MBS). It calculates the time for the securities in a fixed-income portfolio to mature, weighted by the invested amount. Portfolios with higher WARTs are more sensitive to interest rate changes.

WALA, on the other hand, represents the number of months or years until a bond’s maturity multiplied by each percentage. The sum of these subtotals equals the weighted average maturity of the bonds in the portfolio.

What Is Prepayment Risk?

Prepayment risk applies to MBS and ABS and refers to the reduction of a fund’s WART caused by homeowners or debtors refinancing their loans or making early unscheduled payments. These repayments shorten the average maturity of a portfolio and change its risk profile, especially when interest rates decline.

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For example, as mortgages are refinanced, the original loans are completely paid off and replaced with new, lower-interest rate loans. Funds holding MBS with the original mortgage will no longer receive cash flows from that homeowner.

Purpose of a Mortgage-Backed Security (MBS)

MBS take a pool of many mortgages and package them into a single security. This diversification reduces the impact of default from a single home loan, spreading the risk across many mortgages.

Difference Between WAM and WAL

WAM and WAL are primarily used in evaluating money market funds. The main difference between the two is that WAM considers interest rate resets, while WAL does not. The SEC imposes a 120-day limit on WAL for money market mutual funds.

WAM and WAL are primarily used in evaluating money market funds. The main difference between the two is that WAM considers interest rate resets, while WAL does not. The SEC imposes a 120-day limit on WAL for money market mutual funds.

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