What Is the Weighted Average Remaining Term (WART)?
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 the portfolio's assets will take to mature, on average.
WART is closely related to weighted average loan age (WALA), which is its inverse.
- The weighted average remaining term (WART) is a measure of the average time to maturity of a fixed-income portfolio.
- WART is also known as weighted average maturity, or WAM.
- It is often used in relation to mortgage-backed securities (MBS) and other asset-backed securities (ABS), although it can be applied to any fixed-income portfolio.
- Some investors may prefer having exposure to investments with particular maturity profiles, making WART a helpful tool for comparing alternative investments.
- WART is particularly important in assessing a portfolio's interest rate and prepayment risk exposures.
How the Weighted Average Remaining Term (WART) Works
The WART of a portfolio is a helpful metric because it helps investors understand whether the time to maturity of the assets within the portfolio is relatively short or long. For instance, a MBS whose underlying mortgages are all very near to the end of their terms would have a low overall WART, while one with mortgages that have only recently been initiated would have a higher WART. Depending on their risk tolerances and sources of funding, some investors may prefer being exposed to investments with a particular time to maturity.
To calculate the WART of a portfolio, the investor first adds together the outstanding balance of the underlying assets and calculates the size of each asset in relation to that total. Then, the investor would weigh the remaining time to maturity of each asset by using each asset’s relative size. As a final step, they would then add up the weighted times to maturity of each asset to arrive at a WART for the entire portfolio.
WART is commonly used in the disclosure materials associated with MBS, such as those offered by Freddie Mac. In this context, WART serves not to compare two securities but to demonstrate the effects of external forces such as prepayment on the WART of the security. An investor considering a Freddie Mac security would consider these WART calculations when comparing it to an alternative investment or when seeking to construct a portfolio containing different WARTs.
Example of WART
To illustrate, consider an MBS consisting of four mortgage loans, in which loan 1 has $150,000 of 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 therefore $500,000.
To calculate the WART, our next step would be to calculate each mortgage’s share of the total remaining value. By dividing each mortgage’s remaining principal by the $500,000 total, we would find that loan 1 represents 30% of the total, loan 2 represents 40%, loan 3 represents 10%, and loan 4 represents 20%.
We can then calculate the weighted remaining term of each mortgage by multiplying its time to maturity by its share of the $500,000 total. In doing so, we find 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 years
- Loan 4: 20 years x 20% = 4 weighted years
Our final step is to simply add these weighted years together, to arrive at a WART for the entire portfolio. In this case, our WART is: 1.5 + 2.8 + 1 + 4 = 9.3 years.
WART and Interest Rate Risk
In general, 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 larger WARTs, therefore, hold bonds that, on average, will have more interest rate risk than those with smaller WARTs.
One way to reduce this type of risk is through laddering. Bond laddering is an investment strategy that involves purchasing bonds with different maturity dates, which means that the dollars in the portfolio are returned to the investor at different points over time. A laddering strategy allows the owner to reinvest bond maturity proceeds at current interest rates over time, which reduces the risk of reinvesting the entire portfolio when interest rates are low.
Bond laddering helps an income-oriented investor maintain a reasonable interest rate on a bond portfolio, and these investors use WART to assess the portfolio.
WART vs. WALA
Weighted average remaining term (WART) and weighted average loan age (WALA) are both used to estimate the credit risk, interest rate sensitivity, and potential profitability of fixed-income portfolios. WAM tends to be used as a 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 proportion to the dollar amount invested. Portfolios with higher WARTs are more sensitive to interest rate changes.
WALA is essentially the inverse of WART: The number of months or years until the bond’s maturity is multiplied by each percentage, and the sum of the subtotals equals the weighted average maturity of the bonds in the portfolio.
What Is Prepayment Risk?
Prepayment risk applies to MBS and ABS and is the reduction of the fund's WART due to homeowners or other debtors 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 especially a risk in an environment of declining interest rates.
As mortgages, for example, are refinanced, the original loans are completely paid off and replaced with a new, lower-interest rate loan. Funds holding MBS with the original mortgage will no longer 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 idea is that while any single home loan may have idiosyncratic risk that the borrower will default, a portfolio of many mortgages would mute the effect of any single bad loan.