I recently looked up the yield on the Vanguard Intermediate-Term Tax-Exempt municipal bond fund and was surprised by what I saw.
According to Google, Yahoo, and Morningstar, it’s yield was a little over 3%.
Wait a minute… Over 3% for a tax-exempt bond fund? In the current interest rate environment? Really? Yes, really. Well, sort of. Not all yield estimates are created equally.
Upon further investigation, Vanguard was listing the yield as 1.57%. The difference? Both Google and Morningstar were reporting the so-called “distribution yield” whereas Vanguard was reporting the SEC yield.
Looking back with the distribution yield
The distribution yield is calculated as the total amount distributed over the past 30 days divided by the current net asset value (NAV) and then annualized.
In other words…
Divide the distribution amount by the NAV, multiply by 12, and then multiply by 100 to turn it into a percentage. Simple enough.
Note that it’s also possible to estimate the distribution yield over the past 12 months (sometimes referred to as the 12 month yield) in a similar fashion. In this case…
Divide the sum of the distributions from the past 12 months by the NAV and then multiply by 100 to turn it into a percentage. Again, pretty simple.
So, in both cases, the calculation is looking backward and focusing solely on the amounts that have been distributed relative to the current price. Not surprisingly, this isn’t a particularly good predictor of future returns.
Looking ahead with the SEC yield
The SEC yield is a bit more complicated, but the end result is a value that’s analogous to the yield-to-maturity (YTM) of an individual bond. In other words, the SEC yield gives you a more realistic estimate of total returns going forward.
Instances where the distribution yield is higher than the SEC yield are generally due to a fund holding bonds that are trading above par due to their higher-than-current yield. So yes, they’re currently paying out nicely, but that will be partially offset by a price decrease as they approach maturity.
In other words… If you’re looking to invest in a bond mutual fund and want to make an apples-to-apples comparison, you should focus primarily on the SEC yield when evaluating your options and setting your expectations.
