BigJohn wrote: ↑
Tue Apr 17, 2018 3:21 pm
alex_686 wrote: ↑
Tue Apr 17, 2018 11:16 am
I think I know the trick here. The SEC yield covers all income, less expenses. So both coupon and capital appreciation. The fund only distributes coupon income.
Are you sure? I’m no expert but how can any fund company know what the capital appreciation will be looking forward 30 days?
SEC yield is a prior 30-day average yield to maturity (YTM) less expenses. YTM factors in coupon payments (income return) and change in bond price from today until the bond matures at par value of 100 on its maturity date (capital return).
For an individual bond, YTM is a good estimate of total annualized return for a bond held to maturity, with some uncertainty due to uncertainty in the reinvestment rate. However, a bond fund may not hold bonds until maturity, but may sell them at a capital gain or loss, then reinvest the proceeds in other bonds.
Also, although the YTM of a 5-year bond, for example, is a good estimate of annualized return over the next five years, the return over the next one year could be very different for several reasons. First, with a positively sloped yield curve, there could be a larger one-year capital return component than for the bond held to maturity. Next, the capital return component could be positive or negative due to changes in yields. So even with a single individual bond, you don't know what your 1-year return will be unless the bond has only one year until maturity (much less your 30-day return).
Since a bond fund never matures, as with a rolling bond ladder, SEC yield or its cousin average YTM do not provide certainty in the return of a bond fund over any particular holding period, including one equal to the duration of the fund. It's an OK ballpark estimate for a holding period equal to the duration, but the realized annualized return over that period can easily vary by +/- 0.5 percentage points, and even by +/- 1 percentage point or more.
Distribution yield as published by Vanguard (and they don't publish it for VSBSX by the way--not sure why) is average annualized income for the previous calendar month. Income is what you actually receive as dividends. Income includes bond coupon payments minus bond premium amortization plus bond discount accretion, or at least this is what the prospectus says for bond funds I've looked at. So based on what I've seen in the prospectuses, the Oblivious Investor blog post is not exactly correct on this particular point, but this requires more explanation.
The bond premium or discount accrual that is combined with coupon payments to determine income distributions only relates to premium or discount upon purchase. You are required to factor in these accruals in reporting income for tax purposes for an individual bond, but the fund takes care of that for you. Premiums or discounts to par value that arise as a result of market changes after purchase are not factored into income distributions.
So, if a Vanguard fund buys a bond at 100, the only income will be from the coupons. Say that bond later increases to 102 because of a decrease in yields or because of the shape of the yield curve as the bond "rolls down the yield curve". Income for that bond still will be coupon payments only, but you now have received a 2% capital return. If Vanguard now buys more of that same bond at 102, the income for that bond will consist of the same coupon payments, but will be reduced by a premium amortization amount (it would be amortized from 102 to 100 over the remaining lifetime of the bond if it were held to maturity). So the income distribution from the second holding would be lower than the first, even though they are the same bond with the same coupon rate.