Drew O'Neil discusses fixed income market conditions and offers insight for bond investors.
The word yield is used so frequently in fixed income investing that we sometimes take for granted that it is being properly understood and used in the correct context. “Yield” seems relatively straightforward and simple, but in reality, yield is used to describe very different things depending on the context, the product being described, and the point that is being made. Yield could refer to yield-to-maturity, current yield, SEC yield, yield to worst, distribution yield, TTM yield, after-tax yield, taxable equivalent yield, etc. Although these are all some form of yield, they can mean very different things and their values can vary greatly for a single product or investment.
For example, a municipal bond with a 5.25% coupon that is callable in 2023, matures in 2031 and is priced at 115.62 has “yields” of: 1.251%, 3.634%, 4.451%, and 1.985% (yield-to-worst, yield-to-maturity, current yield, and taxable-equivalent yield, respectively). So when you hear someone quote the yield on this bond, they could realistically be quoting any of these numbers. In the same manner, a fixed income mutual fund (the specific fund is not the point) has yields of 3.05% and 1.40% (projected distribution yield and SEC-yield, respectively). Obviously, knowing the specific type of yield that is being quoted is a crucial piece of information for any type of analysis.
Understanding the yield that is being quoted and what each one means is imperative when comparing different product types, as the typical yield quoted for one product category might not be the same type of yield that is generally quoted for another product type. Comparing yields across product types is like comparing apples-to-oranges. Considering the appropriate yield to compare allows an investor to make an informed decision when deciding between investments.
Generally, the typical yield that is quoted for a fixed income mutual fund is some version of a distribution yield. This “yield” measures the cash flow distributed from the fund, roughly equivalent to the ‘current yield’ on an individual bond (except that it uses historical cash flows in the calculation, as future cash flows for a fund are unknown). For an individual bond, the typical yield that is quoted is the yield-to-worst, which tells an investor the worst-case scenario for what their annual return will be (either to a call date or maturity), this is roughly equivalent to an SEC yield on a mutual fund. The problem/confusion generally arises as investors compare the distribution yield on a fund to the yield-to-worst on a bond. This is comparing two completely different measurements and not likely to lead to an informed investment decision.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.