Bonds: TTM vs SEC yield

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FlyingMoose
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Bonds: TTM vs SEC yield

Post by FlyingMoose » Tue Sep 27, 2016 8:25 am

I currently have some money in the Vanguard Int-Term Tax Exempt muni fund.

Morningstar lists a TTM yield that's about twice the SEC yield. The monthly interest payment I get is consistent with the TTM yield and doesn't change much.

In searching around I've seen people say that the SEC yield is more accurate. Does that mean the NAV is expected to go down an amount to bring the two in line?

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alpenglow
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Re: Bonds: TTM vs SEC yield

Post by alpenglow » Tue Sep 27, 2016 8:49 am

Here is a long discussion about your question: viewtopic.php?t=155923

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Kevin M
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Re: Bonds: TTM vs SEC yield

Post by Kevin M » Tue Sep 27, 2016 11:34 am

FlyingMoose wrote: In searching around I've seen people say that the SEC yield is more accurate. Does that mean the NAV is expected to go down an amount to bring the two in line?
SEC yield is a type of yield to maturity (YTM)--it's the average YTM of the fund's holdings over a trailing 30 day period. Vanguard also publishes a distribution yield, which is the annualized income for the previous month. TTM is trailing twelve month distribution yield, published by organizations like Morningstar, which is the yield based on income distributions for the previous 12 months.

The distribution yield published by Vanguard is directly related to the income distributions you received during the previous month. Currently it is much higher, at 2.63%, than the SEC yield at 1.32%. This is because the fund holds many bonds with coupon rates that are higher than current market rates. The prices for these bonds are above par (face value), and will gradually approach par as they approach maturity. Since fund share price is based on the prices of the bonds held by the fund, share price would gradually decline if interest rates did not fall further to offset these declines.

We can actually do some calculations for an individual bond to see this more clearly. A bond with five years to maturity, a YTM of 1.3%, and a coupon rate of 2.8% has a price of 107.22; this is easily calculated with the spreadsheet PRICE function. The current yield of the bond is 2.61%; this is the coupon payment of $2.80 per $100 of bond value divided by the price of 107.22. So like the fund, the current yield of the bond is about twice the YTM.

If the fund bought this bond when it was first issued at a price of 100, then there is no amortization of premium, and the fund will distribute the coupon payment of $2.80 per $100 of bond value annually. This will be reflected in the distribution yield of the fund.

The bond will mature in five years at a price of 100, so the 7.22 premium will gradually evaporate. Of course this could be offset temporarily if yields were to fall further, but eventually the bond will mature at a value of 100. Assuming no change in yields, the gradual decrease in the bond premium will be reflected in a gradual decrease in the share price of a fund that owns the bond.

However, the fund may not hold the bond to maturity, thus it may avoid some of the loss in value in the final year or two as the bond approaches maturity. So fund share price may not fall as much as it would if the fund held the bond to maturity, and this effect is more pronounced the steeper the yield curve is in this region.

It appears that Vanguard Intermediate-Term Tax-Exempt bond fund does hold some bonds at least until they get close to maturity, since 9.4% of the portfolio is for maturity under one year, and 11.5% of the portfolio is for maturities of 1-3 years.

With all of this in mind, we tend to put more emphasis on SEC yield of a bond fund as predictive of total return over 5-10 years (for an intermediate-term fund), as opposed to distribution yield, since it accounts for the changes in bond prices between now and maturity. However, as I've shown in multiple posts, including the one linked earlier in this thread, even SEC yield does not have high accuracy for predicting 5-year or 10-year returns, even though it does have high correlation with subsequent 10-year returns. It has tended to underestimate returns in recent years, due to falling rates and positively-sloped yield curves, but also has overestimated returns over some 5-year and 10-year periods that we can observe with Vanguard bond funds.

Kevin
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FlyingMoose
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Re: Bonds: TTM vs SEC yield

Post by FlyingMoose » Tue Sep 27, 2016 5:28 pm

Kevin,

Thanks for the explanation. It's very helpful.

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patrick013
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Re: Bonds: TTM vs SEC yield

Post by patrick013 » Wed Sep 28, 2016 12:48 pm

If you took the YTM and included the funds expenses, and also
included the accrued but unpaid interest in the calculation, you
would have the SEC Yield.

It's a current measurement of what your return will be based on
market prices today and the fund's current holdings.
age in bonds, buy-and-hold, 10 year business cycle

YDG
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Re: Bonds: TTM vs SEC yield

Post by YDG » Thu Mar 29, 2018 10:10 pm

Why is SEC yield of BNDX consistently and significantly below its TTM yield? (Currently 0.81% and 2.25% respectively.)

lack_ey
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Re: Bonds: TTM vs SEC yield

Post by lack_ey » Thu Mar 29, 2018 10:27 pm

YDG wrote:
Thu Mar 29, 2018 10:10 pm
Why is SEC yield of BNDX consistently and significantly below its TTM yield? (Currently 0.81% and 2.25% respectively.)
This is a bit of a different case, with a good portion of the discrepancy resulting from the currency hedging.

Vanguard Total International Bond ETF (BNDX) pays out the gains from the currency forward contracts, so that's part of the TTM yield you see. There's a hedge return based on the difference in short-term rates in the two currencies (or else there would be risk-free profit to be made on one side). The SEC yield reflects a kind of yield-to-maturity (ish) over the portfolio, looking in local currency terms. It does not account for the currency hedging.

We could see the reverse if short-term yields in the US go below short-term yields in most of the countries used by BNDX. It's just that short rates are higher in the US and have been since the fund's inception (after all, they're negative in much of Europe and Japan, so this was true even when the US was keeping around 0%).

YDG
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Re: Bonds: TTM vs SEC yield

Post by YDG » Mon Apr 02, 2018 3:04 am

Thank you, lack_ey, for the explanation and for the helpful link!

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