Interest in fixed income ETFs has skyrocketed in recent years, as investors have embraced the exchange-traded structure as an efficient means of establishing exposure to a core asset class. Though inflows in recent years have accelerated, the growth of this corner of the ETF market lagged behind the equity space, in part because some of the nuances of bond ETFs [see 101 ETF Lessons Every Advisor Should Learn].
For one, the “yield experience” of most bond ETFs varies drastically from the experience of holding a single bond; most bond ETFs operate indefinitely, maintaining a relatively stable duration and risk profile across time. Investors holding a single bond, on the other hand, will receive a series of coupon payments and return of principal upon maturity, meaning that the duration contracts as the end of the term approaches and risk is reduced.
Assessing the yield potential of a bond ETF can also require a bit more effort. As opposed to a single stream of cash flows, the combination of hundreds or even thousands of debt securities can result in multiple ways to interpret current return. When comparing bond ETFs–or any ETF that makes a distribution–investors have a number of metrics available to them for choosing the right product for their portfolio. Four metrics in particular are commonly displayed for many fixed income ETFs: 30-Day SEC Yield, Average Yield To Maturity, Distribution Yield, and 12-Month Yield.
While these measures are generally similar, there are also some differences in the methodology that may enhance or diminish the usefulness for comparative purposes. Moreover, these metrics often show quite different results; it is not uncommon for the delta between various yield metrics to exceed 100 basis points.
The Devil’s In The Details
With such a wide range of yields, investors may not know which metric to be looking at, or even what each of these yields mean for a particular fixed income ETF. When it comes time to choose the right product for your portfolio, you might find that you prefer one of these metrics over the other. Below, we explain the ins and outs of each measurement and which investors might like which metric for deciphering the bond ETF universe [see also Better-Than-AGG Total Bond Market ETFdb Portfolio].
30-Day SEC Yield
This is a standard calculation, developed by the Securities and Exchange Commission, that is based on the most recent 30-day period for “more fair” bond comparison. More specifically, this figure represents the interest earned in the trailing 30-day period less the fund’s expenses for the period. For traders, and those looking to establish short term positions, this metric may be your best bet, as it represents the most up to date yield available for the product, as well as being a better gauge for the current environment.
The primary advantage of the 30-Day SEC yield is that it is a standardized calculation specified by the SEC, meaning that the same calculation is applied across bond type and ETF issuer. So this metric allows for perhaps the best “apples-to-apples” comparison of bond ETF yields. There are some disadvantages as well; because most bonds are not held to maturity, some prefer the distribution yield as a more meaningful data point.
Average Yield to Maturity
This metric represents the discount rate that equates the fund’s cash flows with its market price. It is representative of the ETF’s NAV, as it takes the average of each individual holding’s discount rate. Average yield to maturity does not take into account fees and expenses, a potential disconnect from the actual yield experienced by investors.
This metric is calculated by aggregating the yield statistics for each of the securities that make up a bond ETF, meaning that it is reflective of the underlying bonds and not necessarily of the ETF itself. Because the yield to maturity metric is fairly straightforward and standardized, this data point should be useful for comparison purposes as well; there is little flexibility in the definition of this field that will diminish comparisons across ETFs from different issuers.
The annual yield that an investor would receive if the most recent distribution stayed constant moving forward. This statistic is calculated by annualizing the most recent distribution, and dividing it by the fund’s current NAV. As such, this metric is subject to wide fluctuations if an ETF’s distribution increases or decreases materially from the last distribution, and may vary based on the frequency of distributions. An ETF that makes monthly distributions will allow for calculation of a relatively up-to-date distribution yield, while those that make distributions quarterly or even annually may show a “stale” figure.
This metric may be useful because it reflects the cash distributions that a bond ETF actually makes, as opposed to a more hypothetical calculation of the yields implied by the underlying securities. But because distributions can and often do change significantly over time, there are some obvious limitations.
This figure is representative of the yield that an investor would have received had they held the ETF for the previous 12-month period. Instead of simply annualizing the most recent distribution, this metric considers all actual income distributions paid over the last 12 months; that total is divided by the most recent NAV and any capital gain distributions made in the previous year. Because actual distributions of the fund are included in the calculation, this measure has appeal in that it reflects the economic reality of the yields experienced by investors; it is based on cash received as opposed to measures of potential yield.
The inclusion of distributions made over the last 12 months has both potential pros and cons. The volatility that may result from annualizing a single payment should be reduced considerably, especially for products that make frequent distributions. But a 12-month yield will also lag its reflection of increases in the yield of a product, since payments from a year ago impact the calculation. Moreover, this metric won’t be available for funds without a full year of operating history, making it less useful for recent additions to the ETF lineup.
There is, of course, no universally superior metric for evaluating the yield potential of a bond; each of the four highlighted above have advantages and disadvantages. An ideal analysis would perhaps incorporate multiple measures, allowing for an understanding of both actual distributions made by the ETF and the risk/return profile of the underlying securities. Just as it is important to always look under the hood of an ETF to understand the portfolio, it is critical to understand the uses and limitations of various metrics that can assist in evaluating potential purchases.
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Disclosure: No positions at time of writing.