Comparing Mutual Funds Fixed Income Yields

Investors often compare yields between different funds to gauge the level of income they may receive from their investment.  The 30-Day SEC Yield is a common calculation provided by bond funds for this purpose, but other calculation methods such as “distribution rates” or “trailing yields” may be available as well.  These calculations convey different information about each fund, and can help lead to better-informed investment decisions.

Distribution rates are usually based on fund distributions paid over time — typically a 12-month period. The fund distributions per share are then divided by the fund’s price per share to arrive at a yield.  This information gives the investor an indication of how much the fund paid on an historical basis.  It is important to note that there is no standardized format, so investors should pay attention to how the calculation was performed.  For instance, the income component may be derived from a recent one-month distribution or a year’s worth of distributions; an averaged income over a longer time frame will be less susceptible to erratic distributions, which could cause large swings in the yield calculation.  The price/principal amount may differ as well.  Morningstar®, an independent mutual fund rating service, calculates its Trailing Twelve Month yield (TTM yield) using a fund’s distributions during the past 12 months and the ending price for that time period.  Alternatively, the Sit Mutual Funds use a similar 12-month history for distributions, but calculate a fund’s average price over that time frame.  The resultant yield figure will be less vulnerable to large swings using an average price rather than a price at a point in time.   

The U.S. Securities and Exchange Commission (SEC) developed the 30-Day SEC Yield as a standardized method for comparing bond funds.  It reflects the dividends and interest earned by a mutual fund during the most recent 30-day period after deducting expenses.  This value is annualized and then divided by the fund’s net asset value at the end of the period, which provides a view of the income-producing potential for a portfolio given its more-recent holdings.  Because this calculation is not based on actual fund distributions, it is more of a theoretical yield that an investor would receive if holdings and other elements remained the same for a year.

Neither method will guarantee the future income or return that will be realized, but analyzing a combination of 30-Day SEC yield and various distribution rates may provide better context of a fund’s performance, as it will capture the current yield potential of the portfolio as well as some historical information.  If there is little difference between the 30-Day SEC Yield and the 12-month distribution rate, then the portfolio’s holdings are likely yielding the same currently as they have been for months (assuming no large interest rate moves or other marketplace changes have taken place).  There can be, and usually are, differences between these types of yields, but these differences may exist solely due to the underlying assumptions inherent within the calculations themselves.  Instances where there are significant deviations from the market or changes in magnitude between yield types should compel investors to research the underlying reasons for the difference.

Montoring these yields is no guarantee that an investor will be able to  uncover instantly all significant changes within a bond portfolio, but when large directional variations occur, it may well be worth contacting the fund company for more information.  Portfolio changes occur for various reasons, such as a strategic shift in response to economic conditions, impacts from large cash inflows/outflows or defaults on securities, which may have a major influence on investment decisions. 

While shifts in portfolio strategy may be the manager’s astute response to economic conditions, investors should determine if a fund will meet their needs.  For example, if interest rates in general fell during a year, investors should reasonably expect a decline in the yield of their bond fund as well.  Instead, if a fund’s current 30-Day SEC Yield is significantly higher than its 12-month distribution rate, it may signal that the fund has added higher-yielding securities with more credit risk, longer maturities, or both.  Another explanation could be that the holdings in the portfolio declined in value relative to the overall marketplace, which would also warrant an explanation from the fund company.   

Conversely, investors should expect their bond fund’s yield to climb after a period of rising rates.  If their fund’s 30-Day SEC Yield was significantly lower than the 12-month distribution rate, there may have been some turnover in the portfolio to lower-yielding securities or the portfolio was possibly more-concentrated in a sector that experienced price appreciation relative to others. 

Using the Sit Tax-Free Income Fund and calendar year 2016, which experienced a fluctuating interest rate environment, provides a good setting for yield comparisons.  Yields for both the Bloomberg-Barclays Aggregate Bond Index and Bloomberg-Barclays Municipal Bond Index — market proxies, respectively, for taxable and municipal bond markets — started 2016 above +2.00%, declined at least -0.50% through June, and then rose to well over 2.00% again by year end.  During the same period, the yield on the Sit Fund similarly shifted.  As of December 31, 2015, the Fund’s 30-Day SEC yield was 3.00% and its 12-month distribution rate was 3.64%.  As rates fell by the end of June, both of these yields dropped to 2.47% and 3.45%, respectively.  By the end of 2016, the Fund’s 30-Day SEC Yield was up to 3.22% and its 12-month distribution rate climbed to 3.56%.  The two yields differ in absolute terms due to varying calculation inputs, but more importantly the directional movements matched fairly well, meaning investors could be confident that there were no major changes in portfolio structure or strategy.

Portfolio adjustments are inevitable over time, and investors should regularly review their holdings to make sure their objectives and risk tolerance are being met.  Sit Mutual Funds publish 30-Day SEC Yields and 12-month distribution rates for all of its bond funds and several stock funds, which are available online or by calling investor services at 800-332-5580.