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Why the big SEC/actual field spread for VFSTX?

Apologies for this trending into misc.invest.mutual-funds territory...
For the past several months, the SEC yield of Vanguard's Short-Term Investment Grade bond fund has been at around 1.89%. But for those same months the actual distribution yield (counting ONLY income dividends, not LTCG or STCG distributions) has been sitting at around 3%.
The SEC yield computation method Vanguard has chosen for this fund is: "based on holdings' yield-to-maturity for last 30 days."
So why has this been so much lower than the distribution yield for months? I understand the difference between YTM and yield. But it's not like the NAV has been dropping. From 12/31/10 to 2/28/11 the NAV has been between $10.76 and $10.80 on distribution.
-- Rich Carreiro snipped-for-privacy@rlcarr.com
Reply to
Rich Carreiro
Without looking more closely than I care to, I cannot say for certain what Vanguard is doing, but I think I can offer a theoretical way this can happen (i.e. a relatively constant NAV, premium bonds [SEC yield lower than current yield] and constant SEC yield).
M* reports the average weighted price of a bond (12/31) as 104.29, and an average weighted maturity of 3.00 years. We'll simplify by using a single bond, rather than a portfolio (which could, of course, be comprised simply of N identical bonds anyway). Using a bond calculator, we see that a coupon rate of 3.37%, with a current price of 104.29, and a 3 year maturity, gives us an effective YTM of 1.88% (about the SEC yield of 1.89%).
Suppose we have a yield curve (YTM) that offers: 2 years: 1.19% 3 years: 1.89%
These yields are rigged so that the bond premium doesn't change (a 2 year bond with a coupon of 3.37% and a YTM of 1.19% will be priced at 104.29 also). I'm assuming here no shift in yield curve - the bond is simply maturing naturally. After a year passes, Vanguard, interested in maintaining an average 3 year maturity, swaps the 2 year bond for a 3 year bond. Same price (since the bond premium didn't change), same coupon, same credit quality, and we're back to a 3 year bond.
In essence, I'm freezing time - the portfolio is a perpetual three year bond, so the premium doesn't change, thus the NAV doesn't drop. I have the feeling I'm cheating somewhere here, because it suggests we should all keep swapping bonds as they age, and capture a higher yield than the YTM. In this case, we hold the bond for a year, get 3.37%/1.0429 = 3.23%, and then do an even swap for our "original" 3 year bond. Maybe this says that I've built a yield curve that's too steep?
Reply to
Mark Freeland
Mark Freeland writes:
I see what you did there! :)
Thanks for the explanation. Modulo the yield curve structure that certainly sounds plausible.
But isn't that what bond mutual funds in fact do? Especially ones chartered to target a particular duration? If nothing else they're forced to do some version of that or else they'll cease to exist as all their holdings eventually mature :).
-- Rich Carreiro snipped-for-privacy@rlcarr.com
Reply to
Rich Carreiro

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