Per Investopdia.com, the term “yield” is defined as the earnings generated on an investment over a particular period of time, expressed as a percentage. Fixed-income investors, in particular, will use a bond’s yield to compare it to other bonds or will use the yield to determine their expected income or return from the bond. Yields can vary based on the type of security, its duration, and other factors. To make matters confusing for investors, there is no shortage of yield calculations available, each with its own purpose.
Below we attempt to define the various yield calculations you are likely to encounter, explain what they each mean and how/when to use them, then illustrate some of the unique cases where caution should be exercised.
The following yield calculations pertain to individual bonds. We will discuss information pertinent to mutual funds, ETFs, and other portfolio-level yield calculations further down in this review. Please note that this is meant to be a high-level tutorial, not a comprehensive analysis of these calculations. Some concepts have been left out, such as assumptions about coupon/distribution reinvestment, etc.
Coupon Yield, also known as the coupon rate: the percent of par value that is paid out each year.
Current Yield: the coupon divided by the current price.
Yield to Maturity (YTM): factors in the price paid and assumes the return of par value at maturity. It essentially provides a total return estimate assuming the bond is held to maturity.
Yield to Call (YTC): the yield of the bond until the time of its call date. It should be stated that the YTC is only valid if the bond is actually called.
Yield to Worst (YTW): calculates the YTM to every possible call date (or other similar bond provisions) and to final maturity and chooses the lowest option. YTW represents the investor’s lowest possible yield outside of the bond defaulting.
Yield to Maturity: an approximation of a fund’s projected annual return over its Weighted Average Maturity (WAM)
Yield to Worst: essentially this is the same calculation as YTM, but it accounts for alternate “maturity” dates
Distribution Yield: sometimes referred to as “dividend yield”
SEC Yield: another backward-looking metric designed to improve upon the distribution yield and provide a standardized way of comparing similar mutual funds.
As you can see, there are several yield calculations for an investor to choose from. Depending on what you are trying to solve for, there is likely one yield calculation that will be more appropriate versus the others.
Outside of understanding and choosing the “right” yield calculation, there is the other challenge in how asset managers publish their data on their website or distribute it to data providers like Morningstar. We suggest using caution before using this data and doing your best to make sure you understand the output and verify it is an apples-to-apples comparison.
On top of there being many different calculations for “yield”, which can be confusing by itself, there are several other caveats to look out for:
Hedged Global/non-US Bonds: Investors need to be careful when looking at the stated YTM of non-US or global fixed income when the product is hedged USD. This is because the YTM can be stated in either or both unhedged and hedged terms. Specifically, we know that index providers like Bloomberg will calculate the YTM of their indexes using the YTM of the underlying bonds without regard to the USD hedge. We also know that fixed-income managers may use a different calculation where the hedge is included in the YTM calculation. This difference in calculation methodology can cause investors to see a wide difference in stated YTM.
TIPS Funds and ETFs: According to Vanguard, for inflation-protected bond funds and ETFs, YTM is calculated by adding the trailing 12‐month inflation adjustment to the current 'real' (i.e., before inflation) YTM of the fund. This means that if inflation persists at the same rate as the previous 12 months, as represented by the trailing 12‐month inflation adjustment, the YTM of the fund going forward (which also assumes income will be reinvested at that rate) would be the same as the published YTM. It’s worth noting that CPI figures are delayed by two months, so there’s a bit of an additional lag in terms of the calculations and adjustments as well.
The SEC yield for TIPS products is essentially the real yield, or the yield before adjusting for inflation. The actual yield on a TIPS fund will be a combination of the SEC yield plus the inflation adjustment. A complete estimate of the fund's forward-looking yield requires that an estimate of future inflation be added to the real yield.
SEC Yield and Global/non-US fixed income: the calculation for SEC yield for global/non-US fixed income hedged USD does not include the hedged component. In other words, the SEC yield is an unhedged yield and won’t accurately reflect the actual experience of the investor when the product is hedged USD.
Data providers (e.g. Morningstar): In a perfect world, investors would be able to quickly see the YTM of their entire fixed-income portfolio and utilize a tool like Morningstar or others to accomplish this.
Unfortunately, we know that not every asset manager publishes a YTM for their products. For investors calculating a portfolio YTM, it is critical to make sure each underlying fund/ETF has the appropriate YTM included.
Separately, investors also need to be aware that Morningstar receives the YTM data from the asset managers themselves, and not all asset managers provide the same exact data or use the same methodologies. For example, some asset managers will publish a YTW in the YTM field believing it is the more accurate/appropriate data point, while others will publish the YTM. In short, this simply means that a comparison of the YTM field in Morningstar may not be an apples-to-apples comparison. Unfortunately, we have also found instances where the data in Morningstar is not the same as the data published on the firm’s website.
Finally, it is important to be sure to make sure you are comparing data from the same date. For example, data can be current, shown for the previous month end, or for some other time period. In particular, when rates are changing rapidly, comparing yields from two different periods can result in large differences in results.
In other words, regardless of the yield calculation being used or the source of the data, it is important to review the data for reasonableness.
East Bay Investment Solutions, a Registered Investment Advisory firm, supplies investment research services under contract.
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About Mario Nardone, CFA
Partner, East Bay Investment Solutions
Mario began his investment career in 1999 with Vanguard mutual funds in Valley Forge, PA, where he consulted institutions and financial advisors on investment policy, portfolio construction, and Exchange-Traded Funds (ETFs). He also held roles as a research analyst, a municipal bond fund specialist, among others during his tenure. In 2003 he earned the Chartered Financial Analyst designation, and he continues to mentor aspiring Charter candidates and young investment professionals.
Mario relocated to Charleston in 2010 to serve as Chief Investment Officer for a financial planning firm before establishing East Bay, the collaborative partner firm of (insert firm name), in 2014. As a Partner at East Bay, Mario serves a select group of Registered Investment Advisor firms as their outsourced Chief Investment Strategist. Responsibilities of this role include continuous oversight of advisor clients’ investments, bespoke strategies for unique situations, client communications, and more.
Mario is Past President of CFA Society South Carolina and Former Chairman of the College of Charleston Finance Department Advisory Board. His approach to investments and the industry has been featured in Investment News, NAPFA Advisor Magazine, South Carolina Public Radio, and other publications and media outlets.
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