A Tale of Two Yields: Part I
by Michael Herbst | 04-30-13
We recently started displaying the 30-day SEC yield for funds, in addition to the trailing 12-month yield. Whereas a fund's TTM yield is based on its distributions over the trailing 12-month period, its SEC yield is based on what the securities in its portfolio are yielding closer to present day.
Neither figure is an indicator of a fund's future income-generating potential. A fund's past income returns, distribution history, and net asset value growth or erosion may shed more light on that potential, but even those factors should not be viewed as predictive. Even so, the comparison of a fund's TTM and SEC yields is arguably more useful than looking at either one in isolation. While both yields reflect income generated by bonds, dividend-paying stocks, and other securities, the SEC yield is mandated for any fund that reports its yields--thus providing a standardized approach to a difficult calculation. An increasing number of firms are providing both figures for investors and to Morningstar. Debate over the minutia of each calculation is beyond the scope of this article. Instead, we'll provide a glimpse into what a comparison of a fund's TTM and SEC yields can reveal.
The Road Behind You Is Part of the Road Ahead
The 30-day SEC Yield calculation is more complex (click here and search for "30-day"). While it represents the investment income per share that a fund's portfolio earned during the trailing 30-day period after expenses, it doesn't reflect what a fund may have actually distributed to fund shareholders. Think of the SEC yield as a pair of side-view mirrors to complement the rear-view mirror.
Adjust Those Mirrors
To make a better comparison across the funds, I calculated each fund's SEC yield as a percentage of its TTM yield (SEC yield divided by TTM yield). Where that figure is close to 100%, the difference between the fund's two yields is narrow, meaning there's not much difference between what the securities in a fund's portfolio are yielding today and what its distributions over the trailing 12-month period have been. There can be--and often there is--a disconnect between the two yields, because SEC yield is an accounting convention for measuring the income that a portfolio is generating, while TTM yield is a measure of how the fund has managed the distribution of that income. Seeing an SEC yield that's higher than a fund's TTM yield does not necessarily mean the fund will be paying out higher distributions going forward, and a TTM yield that's higher than the SEC yield doesn't necessarily mean a fund will be able to sustain those distributions going forward.
The percentage itself is neither good nor bad. Recent, sizable market movements may cause the figure to move away from 100%, as we'll see with many of the funds discussed below. A manager's portfolio adjustments also may cause the figure to shift. If that percentage stands out from peers, it's worth digging into the fund's portfolio to see what's going on. For instance, a bond-heavy fund that's been able to keep that figure close to 100% over the past year as yields have continued to fall may have taken on more credit risk or interest-rate risk in order to keep its yield relatively high.
Intermediate-Term Bond Funds: Low Yields Are Closer Than They Appear
That gap is largest for our funds with bigger stakes in low-yielding U.S. government bonds: Vanguard Total Bond Market ETF BND, iShares Barclays Intermediate Government/Credit Bond GVI, and PIMCO Total Return PTTRX. My colleague Eric Jacobson recently wrote about how many core bond fund managers benchmarked to the Barclays U.S. Aggregate Bond Index are hunting in higher-yielding areas, such as emerging markets, corporate debt, and nonagency mortgage-backed fare, since U.S. government bond yields are artificially low or even negative after accounting for inflation.
The SEC yields on the corporate-heavy Dodge & Cox Income DODIX and wider-ranging Metropolitan West Total Return Bond MWTRX have stayed closer to their TTM yields. Both funds have taken some gains from credit-sensitive securities over the past year, and both have scaled back on interest-rate risk over the past few years. Yet the relatively narrow gap between their TTM and SEC yields suggests neither fund has jammed on the brakes. Had they scaled back credit risk or interest-rate risk more dramatically, that gap would be wider.
Multisector-Bond Funds: Better Clean Your Windshield
It's difficult to draw broader conclusions for the multisector bond camp because of the range of strategies in the category. For instance, the 2.54% SEC yield on PIMCO Diversified Income PDVAX is only half its 5.06% TTM yield. That gap reflects the past year's falling yields and the fact that its management prefers to spread its bets across multiple areas (generally a mix of investment-grade and high-yield corporate bonds, emerging markets, nonagency mortgages, and currencies) rather than load up in the highest-yielding parts of the market. On a slightly different note, Loomis Sayles Strategic Income NEFZX has been taking gains in its bond sleeve and has redeployed some of those assets into a 19% stake in preferred and dividend-paying common stock. That move reduced the fund's exposure to some pricey bonds, but it has added a dose of equity-market risk.
Investors in multisector-bond funds best look out their windshields rather than focus on their mirrors. With bond prices landing well above 100 cents on the dollar across wide swaths of the bond market, they could be in for a rude awakening should risk aversion seize the market. In addition, neither TTM nor SEC yields reflect the potential impact of future defaults, distressed sales out of a fund's portfolio, or liquidity risk. Nor do they reflect growing reinvestment risk, as many corporate and government issuers have replaced higher-coupon debt with lower-coupon bonds in recent years.
Municipal-Bond Funds: Shock Absorbers Won't Fix a Flat Tire
In some respects, muni bonds' tax-exempt status can be viewed as a shock absorber. That advantage doesn't necessarily mean muni-bond funds will be less volatile than their taxable brethren, but it gives their yields a boost without adding risk. The SEC yields on our selected muni-bond funds in the above table are 0.47 to 2.17 percentage points higher on a tax-equivalent basis for investors in the 28% income tax bracket. Muni-fund managers have fewer levers to pull than multisector bond managers, but those able and willing to take on greater credit risk via investment in bonds rated BBB and below or greater interest-rate risk via longer-maturity bonds or other instruments have more leeway to maintain higher yields in today's low-yielding environment.
The data above supports that view. As of late, Vanguard High-Yield Tax-Exempt VWAHX and American Funds Tax-Exempt Bond AFTEX both held roughly 20% of assets in bonds rated BBB and below, just over double their average muni-national intermediate rival's 9%. In addition, their average effective durations were 1.3 and 2.1 years longer, respectively, than their typical rival. PIMCO Intermediate Municipal Bond ETF MUNI holds no non-investment-grade bonds, one reason its TTM yield isn't as high. But its average effective duration of 6.8 years is one of the longest in the category, and one reason why its SEC yield hasn't fallen as far. The Vanguard and PIMCO funds' relatively low expense ratios also take smaller bites out of their SEC yields, a perennial advantage that's even more valuable as yields grind lower.
Bigger doses of credit and interest-rate risk have helped our selected high-yield muni funds maintain a higher percentage of their TTM yields. Yet what looks like a fairly tight range of 73% to 86% belies a big difference in risk profiles. MFS Municipal High-Income MMHYX and T. Rowe Price Tax-Free High Yield PRFHX offer comparable SEC yields and expense ratios, and both recently had roughly 50% of assets parked in bonds rated BBB or below. Yet the T. Rowe fund has reduced its average effective duration by roughly 1.8 years since mid-2010, thus reducing the portfolio's interest-rate risk, while the MFS fund's 9.9-year average effective duration is longer than virtually all of its peers'.
Of our selected muni funds, Oppenheimer Rochester National Muni ORNAX had the narrowest gap between its TTM and SEC yields. Its 9.2-year average duration clocks in at the longer end of the high-yield muni category. And beyond a 34.4% stake in bonds rated BBB or below, it had an additional 40.9% invested in nonrated bonds. The fund's riskier profile has courted plenty of volatility in the past--including a 49% loss in 2008, from which the fund hasn't yet fully recovered on an NAV basis. This fund is a reminder that investors who are overly focused on yield and don't also consider the risk of capital losses may very well be setting themselves up for a flat tire.
Are We There Yet?
In future articles, we'll take a look at what comparison of TTM and SEC yields can reveal for equity and asset-allocation funds. We'll also dig deeper into funds' distribution histories and NAV growth/erosion to better gauge their income stability. Finally, we'll see what parallels we can draw with closed-end funds, whose stated distribution rates and structural characteristics provide additional highway markers for income-seeking investors. My colleague Mike Taggart sheds valuable light on that last point here, but we'll revisit all of these topics in our next road trip.
Michael Herbst owns shares in the following stocks mentioned above: PTTRX
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