When it comes to fixed income investing, the most common question clients ask is, “What’s the yield?” Since yield is an important component of a bond investment’s total return, investors need to be able to answer this question in order to accurately assess whether an investment is right for them.
To be honest, I usually answer by saying “Well, it depends on what you want to measure.” There are many different types of yield out there, and the “right” one will vary based on the situation.
The number of different types of yields for fixed income funds is almost endless. If you research a particular fund, you will often find metrics like current yield, yield to maturity, yield to worst, yield to call, SEC yield, distribution yield, tax equivalent yield and real yield, just to name a few. To help you understand which yield you should be looking at, let’s talk about the most common yield metrics and how they can be used.
What it means: This is the annual yield an investor would receive if the most recent fund distribution and current fund price stayed the same going forward. It’s calculated by dividing the most recent fund distribution by the most recent net asset value (NAV) and multiplying the result by 12.
Matt’s take: Distribution yield measures what a fund just paid out to investors, so it’s generally a good indicator of current income. The size of the distribution reflects the yield level that bonds were at when they entered into the fund. Because of this, the distribution yield is slow to adjust to changes in market yields. In addition, as fund distributions can vary month to month, it may not give you the best idea of what a fund has been paying out, which is why it’s also good to look at the 12-month yield.
Average Yield to Maturity (YTM)
What it means: This yield measure represents the weighted average YTM of the bonds in the fund as of a date, assuming that the bonds will be held to maturity and that all coupon payments and the final principal payment will be made on schedule. It’s the only yield measure that is gross instead of net of fees (such as the fund’s expense ratio), which means that fees should be deducted when comparing to other yield measures.
Matt’s take: YTM is a good indicator of what the bonds in the fund are yielding at a current point in time. When bond yields change in the market, the YTM on a fund also changes, and future bonds acquired by a fund will then be acquired at current YTM rates. In this way YTM can be a good indicator of where the fund distribution may be headed (see below).