Bond yield metrics: How they work
“Yield” is one of the most commonly used terms when discussing bonds and bond funds. And yet, it’s often not well understood, especially in the context of different types of yield metrics.
What are the different yield metrics?
Broadly, a bond’s yield is measured by two very different metrics—performance/return metrics and distribution metrics. That is:
- Yield-to-maturity (YTM) is a forward-looking metric for the expected return of a bond (if held to maturity with no defaults). It helps investors compare bonds and understand how changes in interest rates might affect their returns.
- Distribution yield, or trailing 12-month (TTM) yield, is a backward-looking metric that captures the income distributed over the past 12 months as a percentage of the investment's value. It helps investors understand the current income stream, particularly in mutual funds and ETFs.
For example, a zero coupon 10-year bond will obviously have a zero-distribution yield, but it can have a sizable YTM depending on the level of discount at which it was purchased. The YTM/return of this bond will be the difference between the discounted purchase price and the price at maturity, which is par at 100, annualized.
Figure 1: How bond yield metrics can shape your investment analysis
| Yield metric | Description | Advantages | Disadvantages |
|---|---|---|---|
| Total return yields | |||
Yield-to-maturity (YTM) |
Forward looking; estimates the total return if held to maturity (income + price); considers the bond's current price, face value, coupon rate, and years to maturity | Captures the total return; helps in comparing different bonds and understanding their potential returns | Not a good gauge of income distribution; assumes coupon payments are reinvested at the YTM; assumes bonds will be held to maturity (not usually the case with bond funds) |
| Yield-to-worst (YTW) | Similar to YTM but assumes all options are exercised (e.g., call options, prepayment options) | Most conservative forward-looking yield metric since it will always be lower than YTM (or equal, if no options exist) | Same as above; it is highly unlikely that all options are exercised making YTM a more realistic yield metric |
| Distribution yields | |||
30-day SEC yield |
Backward looking; estimates income earned over a 30-day period divided by last NAV (annualized) | Standardized calculation allowing for better fund comparisons | May not capture all sources of income like realized gains and other forms of income that are not predictable or necessarily repeatable; hard to calculate and involves accounting rules, which can lead to distortions |
| Current yield | Backward looking; latest distribution divided by last NAV (annualized) | Easy to calculate vs. SEC yield and captures all distributions | May vary from month to month due to the timing, size, and nature of the distributions |
| 12-month yield | Backward looking; total distributions over prior 12 months divided by last NAV | Easy to calculate vs. SEC yield and captures all distributions; generally, more stable vs. current yield | May include large one-time distributions like capital gain distributions at the end of the year, potentially overstating the income generated |
How to analyze which bond has the higher yield
When deciding whether to invest in a bond or bond fund, investors should consider what the different return and distribution yield metrics may be indicating. The table below shows two hypothetical bonds, a 5-year bond with 5% coupon, priced at $105 and a 1-year bond with 3% coupon, priced at $95.
Figure 2: Comparing two bonds
| Maturity | Coupon | Price | YTM | Current Yield | |
|---|---|---|---|---|---|
| Bond A | 5 years | 5.0% | $105 | 3.88% | 4.76% |
| Bond B | 1 year | 1.0% | $96 | 5.21% | 3.16% |
Bond A has a higher current yield due to the higher coupon as the bond distributes a higher level of income compared to Bond B.
But Bond B has a higher YTM due to the discounted price as the bond matures at par 100.
The best choice depends on the investor’s goals. Investors seeking income may find Bond A more attractive given its higher distributions. Investors focused more on expected total returns may prefer Bond B due to its higher YTM.
Using additional yield metrics
Let’s compare the hypothetical Fund A and Fund B, both intermediate core bond strategies. Here, we’ll also analyze the yield to worst (YTW), 30-day SEC yield, and current yield.
Total return measures like yield to maturity (YTM) and YTW reflect the lowest possible return, having considered potential call provisions or other factors that might shorten the investment period. Both metrics should be considered to select the most suitable bond or bond fund for an investor’s objectives.
A distribution yield, the 30-day SEC yield is an annualized measure of the income earned by a bond fund over the previous 30 days. It reflects the dividends and interest earned, less any fund expenses. The SEC yield is calculated by dividing the net investment income earned over the 30-day period by the maximum offering price per share at the end of the period.
And current yield is an investment's annual income (interest or dividends) divided by the current price of the security, another distribution yield.
Figure 3: Comparing two funds and their yield metrics
| YTM | YTW | 30-day SEC yield | Current yield | 12-month yield | |
|---|---|---|---|---|---|
| Fund A | 5.5% | 5.5% | 4.9% | 5.0% | 8.0% |
| Fund B | 6.0% | 5.7% | 1.9% | 2.0% | - |
Analyzing all these various yield metrics reveals that:
- Fund B has a higher YTM and YTW due mainly to its higher exposure to corporate credit vs. Treasurys.
- Fund B has a lower current yield as its primary objective is to seek risk-adjusted total returns, while Fund A’s primary objective is to provide consistent income.
- Fund A’s 12-month yield is significantly higher than its current yield indicating a potential one-time large distribution like a capital gain distribution at the end of the year.
- Fund B does not have a 12-month yield as it was recently incepted and lacks the 12-month track record.
- Fund B’s YTW is lower than its YTM due to the call options of some of the underlying bonds.
So, which fund is best? No surprise, it depends on the investor.
- If maximizing total return is the main objective, then Fund B would most likely be more suitable given the higher expected forward-looking YTM/YTW.
- If consistent income is an important consideration, then Fund A would probably be more appropriate given its higher current/SEC yield.
Bottom line: Knowledge is power
Understanding yield metrics can help you properly evaluate bond strategies and choose investments according to your goals.