Why the big SEC/actual field spread for VFSTX?

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:

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

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?

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