Quick, what's your fund's mil rate?
What You Don't Know
About Bond Fund Yields
CAN Hurt You
WHEN YOUR BOND advertises an "SEC 30day annualized yield" of, say, 8.54%, does that mean the fund actually pays income at an 8.54% rate? The answer is ... maybe. While the standard Securities and Exchange Commission formula, which bond funds are required to use when they cite yields, can be useful in comparing payouts of income, it can also mislead.
What the SEC formula computes is yield to maturity of the fund's portfolio over the previous 30 days, projected forward over a full year. What it doesn't always do is figure the real yield. For that, you need to ask for the "mil rate," usually expressed in fractions of a penny per share per day.
To estimate the real, noncompounded yield of a bond fundyour yield if you don't reinvest dividendsmultiply the mil rate by the 365 days in the year and divide that by the current net asset value (NAV) per share. To figure the annualized milrate yield, also called the distribution yield, which you get if you reinvest income distributions, use a financial calculator or call the fund's "800" number. (Note to armchair mathematicians: You multiply the latest mil rate by 30, divide by the NAV, add 1, multiply the result by itself 11 times, subtract 1 and multiply by 100.)
For example, Fidelity New Markets Income, a volatile emergingmarkets bond fund, was recently paying a mil rate of $.001773. At an NAV of $9.49, that works out to an annualized yield to shareholders of 6.93%about 1.5 percentage points less than the SEC 30day annualized yield of 8.45%, which the fund was advertising.
Meanwhile, the 12month yield that was actually paid to shareholders by New Markets Income was 6.4%, according to Micropal Inc., our supplier of mutual fund data. (This figure represents the income from the prior 12 months divided by the sum of the NAV and capital gains distributed during that period.)
The 12month yield is an accurate figure. It reflects past conditions as well as current ones, so it's easy to see why it would differ from the 30day yield. But why are the SEC 30day annualized yield and the distribution yieldwhich ought to be identicalso different in this instance? According to Fidelity Investments, the reason for the disparity is that the fund is invested in speculative, deeply discounted bonds. Because the SEC formula assumes that all bonds will be held to maturity and that all bonds in a portfolio are paying interest, its yield computations are particularly distorted when applied to funds like this one.
Emergingmarkets junkbond funds aren't the only ones whose yields are skewed by the SEC standard. The Benham Target Maturities funds invest exclusively in zerocoupon Treasury securities that come due in the same year, such as 2005 or 2010. These bonds pay no current interest. They are purchased at a discount and then redeemed at face value at maturity. Dividends of the Benham target funds are really "phantom interest" reflected in the price of the bonds as they gain value over time.
Which yield should you use when? The 12month yield is most useful in a period of stable rates. The 30day distribution yield, based on the mil rate, is the most accurate barometer of current income, especially for funds with exotic portfolios. The big plus of the SEC 30day annualized yield is that all funds must use it in reporting their yields. Thus, it levels the playing field. But if you really want the current yield, rely on the mil rate.
."A Lot You Didn't Know About Bond Fund Yierlds" originally appeared in the September 1994 issue of Kiplinger's Personal Finance Magazine.
© Copyright 1994 Bruce Brown
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