SEC Yield

The SEC yield is the yield a fund calculates by the method the SEC prescribes in Form N-1A, the registration form for open-end funds, which include mutual funds and exchange-traded funds organized as open-end funds. For a fund other than a money market fund, the form instructs it to "calculate the Fund's yield by dividing the net investment income per share earned during the period by the maximum offering price per share on the last day of the period," using a 30-day or one-month period. The name is informal: the form calls the figure the fund's "yield," and the SEC's advertising rule calls it "current yield." It is not the same as the current yield of a single bond, which the SEC's investor glossary defines as a bond's interest payment divided by its market price. Money market funds quote a separate 7-day yield computed under the same form.

What goes into the formula. Form N-1A Item 26(b)(4) sets the calculation as YIELD = 2 × [((a − b) ÷ (c × d) + 1)^6 − 1], where a is the dividends and interest the fund earned during the period, b is its expenses accrued for the period (net of reimbursements), c is the average daily number of shares entitled to dividends and d is the maximum offering price per share on the last day. The inner fraction is one month's net investment income per dollar of share price. Raising it to the sixth power and doubling the result expresses that monthly figure as an annual rate compounded twice a year, the convention used for bond yields. Because the denominator is the maximum offering price, a fund with a front-end sales load reports a lower SEC yield than the same portfolio would show on its net asset value.

Why bond income is measured by yield to maturity. The instructions tell the fund to compute interest on its debt holdings from "the yield to maturity of each obligation held by the Fund based on the market value of the obligation," rather than from the coupons the bonds actually pay. (One exception: for a tax-exempt bond bought at a market discount, the coupon rate is used instead.) That choice is the point of the standard. A bond bought above face value pays a coupon higher than the return it will deliver, because the premium paid is lost by maturity. Counting coupons alone would let a fund holding such bonds advertise income it will partly give back; measuring by yield to maturity builds that loss in. Dividends on stocks are accrued at a daily rate set by the stated dividend, and the fund's expenses, including any 12b-1 fees, are subtracted.

SEC yield against distribution yield. Funds may also show a distribution yield or distribution rate. FINRA, describing closed-end funds, explains that a distribution rate is generally calculated "by annualizing the most recent amount paid to investors and dividing the resulting amount by either the market price or the fund's NAV." That figure reports what the fund paid, which can include coupon income later offset by bond premiums, gains or even a return of capital. The SEC yield reports what the holdings earned on a standardized basis. The two can differ substantially, and neither one is a total return, which also counts changes in the share price.

The money market version. Item 26(a) sets a separate method for money market funds. The 7-day yield takes the net change in a one-share account over the last 7 days, excluding capital changes, subtracts account charges, and multiplies that base-period return by 365/7. The 7-day effective yield compounds the same return instead: [(base period return + 1)^(365/7)] − 1. Realized and unrealized gains and losses are excluded from both. In the prospectus's performance summary, a money market fund may show its 7-day yield or give a toll-free number for obtaining the current figure.

How the yield appears in advertising. The SEC's Rule 482 governs fund advertisements, and it treats the two kinds of fund differently. An open-end fund other than a money market fund that quotes a current yield must compute it by the Form N-1A method, and the yield must be "accompanied by quotations of total return" and set out "in no greater prominence than the required quotations of total return." A money market fund may quote its current and effective yields under Rule 482(e) without that requirement. The rule runs the other way for those funds: if a money market fund quotes a total return, it must show its current yield beside it, and where the two differ materially it must state "that the yield quotation more closely reflects the current earnings of the money market fund than the total return quotation."

The fund adds up the dividends and interest its holdings earned over the 30-day period, with interest on each bond figured from its yield to maturity, subtracts the expenses it accrued, divides by the number of shares to get income per share, divides again by the share price, and annualizes the result by the Form N-1A formula.

For example, with round made-up numbers: a bond fund has 50 million shares entitled to dividends, a maximum offering price of $10.00 a share, $1,050,000 of interest and dividends earned in the 30 days, and $150,000 of expenses. Net investment income is $900,000, which is $0.018 a share, or 0.18% of the $10.00 share price. Under the formula, 1.0018 raised to the sixth power is about 1.01085; subtracting 1 and doubling gives about 0.0217, a 30-day SEC yield of about 2.17%. Multiplying the monthly 0.18% by twelve would give 2.16%; the small difference is the compounding the formula builds in.

A money market fund works the same way over 7 days. Suppose a one-share account rises by $0.0008 per dollar of value over the week from net investment income. The 7-day yield is 0.0008 × 365/7, about 4.17%. The 7-day effective yield, 1.0008 raised to the power 365/7 minus 1, is about 4.26%, higher because it assumes the weekly income is reinvested.

Pros

• Every fund computes it the same way, so it gives a consistent basis for comparing the income of two bond funds.
• Measuring bond income by yield to maturity stops premium bonds from inflating the figure.
• It is net of fund expenses, so a costly fund's income is shown after its costs.

Cons

• It covers only the most recent 30 days (7 for a money market fund), so it changes as rates and holdings change.
• It is not a total return: it ignores changes in the share price.
• It can differ from the cash the fund actually distributes, which is what a shareholder receives.
• It does not reflect taxes, and tax-exempt and taxable funds need a tax-equivalent yield to be compared.