For bond funds, the average maturity of the bonds in the portfolio can be used as a market risk measure, rather than beta. The volatility of a bond fund is determined by how the fund reacts primarily to changes in interest rates, although high-yield (junk) bond funds and international bond funds can be affected significantly by factors other than interest rates. When interest rates rise, bond funds fall in value; and, conversely, when interest rates fall, bond mutual funds rise in value. The longer the average maturity of the bond fund, the greater will be the variation in the return on the bond fund when interest rates change. Bond mutual fund investors with less risk tolerance and shorter holding periods should seek shorter- maturity funds, and longer-term bond fund investors who are more risk tolerant will find funds with longer maturities a better match.
In the case where a bond fund holds mortgage-backed securities, average maturity may not capture the potential for decline in effective maturity when interest rates fall and mortgages are refinanced. Some mortgage funds also use derivatives, highly leveraged financial instruments that derive their value from movements in specific interest rates or indexes, which further complicate an analysis of their risk. Bond funds that hold corporate bonds and municipal bonds also face changing effective maturities when interest rates decline and bond issuers call bonds before maturity.
