Is there any way to get a better determination of future bond fund yields and what would end up in your pocket, besides the 30 day SEC yield which is the recommended method to compare fund yields. I find that many funds have a "Distribution Yield" which is far greater than the SEC yield. Not all funds publish their distribution yields but this can be easily determined . Also some funds distribute dividends quarterly which would cause differences as SEC yield is based only on the last 30 days and the fund may not have distributed dividends in the past 30 days.Also yields can deviate sometimes quite a bit month to month. Example. NTFIX has an SEC yield of 0.59% but a 30 day distribution yield of 2.05%. Google NTFIX and click on the Dupree funds page to get this information. If they are so different why is the 30 day SEC yield supposedly the recommended yield to compare to other fund yields when they are so drastically different compared to distribution yields? TTM yields are of course useless if yields have not been stable in the past 12 months. If anyone knows of any other better way to better predict your future bond fund yield please share. Comments?
Comments
Simplest case: a one year bond sold at par (face value), maturing in a year, and paying a 1% coupon at maturity. So you can buy the bond for $100, and at the end of a year it returns your $100 principal and pays you $1 in interest. I think we can agree that the annualized yield on the bond is 1%.
Now take a one year zero coupon bond. You purchase it for $99.01 and at the end of a year it pays you its face value of $100. You get 1% more than you paid for the bond. What's its yield? Its yield to maturity (YTM) is 1%. That's what in a mutual fund would be called SEC yield. What's its distribution yield? 0% since it is not making any coupon (interest) payments.
Next, consider a one year bond, maturing in a year and paying 2% of face value at maturity. If the current market rate is 1%, then you'll have to pay $100.99 to buy it. At the end of the year, you'll receive $100 from the face value and $2 in interest. From your perspective you'll get back $1.01 more than you paid, i.e. you'll have gotten the 1% market rate on a one year bond. Your YTM (SEC yield) will still be 1%. Your distribution yield will have been 2%, even as you were losing 1% in principal.
So what does yield mean to you? All three bonds give you the same return of 1%. You can get a higher distribution yield but you'll have to pay up for it and you won't wind up with more in the end. That's what you're seeing in NTFIX.
You're paying an average of $116.46 (per M*) for every $100 worth of bonds in NTFIX. Even as it makes above market rate interest payments, those bonds are losing value as they get closer and closer to maturity. Your net annual return (assuming market rates don't change) will be around 0.59%.
If you own a bond and sell it before maturity, even assuming that rates remain the same, you'll get a bit more than YTM. This is because longer term bonds pay higher rates. Since SEC yield reflects YTM, I don't believe this return is reflected in that yield.
Think of a two year bond paying interest annually. Let's say that market rate for a two year bond is 2% and market rate on a one year bond is 1%. (This time I'll ignore pennies for simplicity). If the two year bond pays 2% each year, it will cost you $100 (par).
A year after buying, you get a 2% interest payment. You're now holding a 1 year bond with a 2% coupon (that's above the 1% market rate for a one year bond). So you're able to sell that bond for $101 (1% premium). Your net return: 2% market rate interest plus 1% in capital gain.
[A buyer of your bond, if holding to maturity would net 1% on that bond (2% coupon less 1% loss in value). There's your 4% total return over two years.]
There's no difference between you doing this with your own bonds and a fund manager doing this with the fund's portfolio. You get more total return by turning over bonds because you're taking on more risk.
When holding a two year bond to maturity the average maturity over that time is one year. If instead you sell a two year bond after a year (and replace it with another two year bond), your average maturity over time is 1.5 years. You're always holding a bond that matures between one and two years from now.
We didn't assume rates were changing here - just that we didn't have an inverted yield curve where shorter bonds pay higher yields than longer bonds.
Rates changing complicates this. If you swap one bond for another of the same maturity, nothing's going to change. It's as if you sold your bond and then simply repurchased it. Your sale price and your purchase price will be equally affected by the rate change.
But if you're selling shorter maturity bonds and replacing them with longer maturity ones, then a change in the yield curve is going to affect how much you get for extending that average maturity. In ways I honestly don't want to work through right now