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Recently read a Forbes article about this ETF. Curious if others are familiar. I’m going to start doing a little research. Stated goal is to provide a ‘steady’ 7% return utilizing a mixture of financial instruments. I realize the ETF doesn’t not have a long track record.
I agree with you that in general ROC is destructive. This is why I tend to suggest caution in focusing too much on current yield. Whether from a CEF, ETF, or OEF, including OEFs comprised of bonds.
If market rate on a one year bond is 1% and your bond has a 2% coupon, it will be priced at 101. A year from now (assuming one coupon per year for simplicity) you'll get that 2% in "interest" but you'll have lost 1% in principal. That 2% payment is really 1% in interest and 1% ROC. In fact, for individual bonds, that's how the IRS treats it. See boxes 11-13 on form 1099-INT.
@msf and anyone else who might know. Do bond fund managers typically try and sell bonds before they mature to decrease the chance of losing principal? Is this why the turnover can be so high in some funds. I just have had a hard time understanding why the distribution yields can be so much greater than SEC yields (without ROC) for years at a time in many funds. Any thoughts would be appreciated. And thank you @msf for your wonderful explanations about similiar questions in the past. Fundly
The high turnover appears to be more for making profit than protecting against loss. For example:
A funds turnover ratio can vary and rise due to a plethora of causes. Pastor, Stambaugh, and Taylor (2016) suggest that turnover ratios are higher when the market environment falls within certain parameters. Their findings suggest that turnover ratios are higher in an environment where investor sentiment is high, stock volatility is high, and stock market liquidity is low. These market characteristics allow for more profitable opportunities for fund managers, as well as an increase in flows in to the funds as investor sentiment rises. These parameters are similar to that of the recovery period following the time period one which is the time period analyzed in the research by Li, Klein, and Zhao (2012) who find that the highest turnover ratios are found during the time following a financial crisis. Following a time when markets are severely down it is not unexpected that many old positions would be sold off in order to replace them with new more promising positions that arise as the market begins to see positive returns again.
SEC yield is based on the idea of constant yield to maturity. Think about a yield curve where 2 year bonds pay 2% to maturity and one year bonds pay 1%. If you buy a two year bond with 2% YTM, you're getting a total of 4% interest. After a year, the market says that it will pay 1% interest.
The price adjusts accordingly though effectively you're getting 3% for that first year and 1% for the second year. If a fund continually buys two year bonds and sells them off after a year, it achieves a 3% yield. That comes at a cost. The average maturity of that fund is 1.5 years (bonds are all between one and two years from maturity). If the fund held the bonds to maturity, the fund's average maturity would be one year. Shorter maturity and less risk.
Comments
Here's M*'s writeup, via Fidelity, of pass-through and of and constructive ROC.
https://www.fidelity.com/learning-center/investment-products/closed-end-funds/return-of-capital-part-two
I agree with you that in general ROC is destructive. This is why I tend to suggest caution in focusing too much on current yield. Whether from a CEF, ETF, or OEF, including OEFs comprised of bonds.
If market rate on a one year bond is 1% and your bond has a 2% coupon, it will be priced at 101. A year from now (assuming one coupon per year for simplicity) you'll get that 2% in "interest" but you'll have lost 1% in principal. That 2% payment is really 1% in interest and 1% ROC. In fact, for individual bonds, that's how the IRS treats it. See boxes 11-13 on form 1099-INT.
https://wiki.1099pro.com/download/attachments/89456651/image2020-5-18_11-3-3.png
Do bond fund managers typically try and sell bonds before they mature to decrease the chance of losing principal? Is this why the turnover can be so high in some funds. I just have had a hard time understanding why the distribution yields can be so much greater than SEC yields (without ROC) for years at a time in many funds. Any thoughts would be appreciated. And thank you @msf for your wonderful explanations about similiar questions in the past. Fundly
SEC yield is based on the idea of constant yield to maturity. Think about a yield curve where 2 year bonds pay 2% to maturity and one year bonds pay 1%. If you buy a two year bond with 2% YTM, you're getting a total of 4% interest. After a year, the market says that it will pay 1% interest.
The price adjusts accordingly though effectively you're getting 3% for that first year and 1% for the second year. If a fund continually buys two year bonds and sells them off after a year, it achieves a 3% yield. That comes at a cost. The average maturity of that fund is 1.5 years (bonds are all between one and two years from maturity). If the fund held the bonds to maturity, the fund's average maturity would be one year. Shorter maturity and less risk.
Here's a brief paper explaining this phenomenon:
https://www.northerntrust.com/documents/commentary/investment-commentary/maturity-bond-funds-vs-individual-bonds.pdf