Ask ii: what do the different types of yields on funds mean?

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Steve asks: I have seen lots of different types of bond yields stated on bond funds, but am unsure what they really mean with regards to the income I expect to get from a portfolio.

For example, I saw a fund manager say that their portfolio yielded 8%, but the “distribution” yield on the factsheet was closer to 4%, so what do the two numbers refer to and which is more important?

Sam Benstead, deputy collectives editor, interactive investor, (pictured above) says: Steve is definitely not alone in his confusion. Understanding yields, particularly for bond funds, is difficult – but very important.

Not only do investors come across a wide range of terms associated with yield, including distribution, running, annualised, or redemption, but yields are never set in stone, as fund managers will constantly chop and change portfolios, and market conditions can change rapidly.

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There are two key terms that bonds investors need to get their heads around: yield to maturity (also known as the running or redemption yield), and distribution yield.

Assuming all portfolio coupon payments (the level of interest promised) are made, and the principals on bonds (amount lent) are returned, the yield to maturity of a portfolio is the total annual return of a fund if all bonds are held to maturity. This assumes no portfolio changes. 

It's a measure that bond managers use to assess what their portfolio is forecast to return, including when they get their capital back when a bond matures.

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The yield on a factsheet is normally the distribution yield, which is an indication of what investors may get as income payments over the next 12 months, based on the last income distribution. This also assumes no trades are made in the portfolio. It's a measure of income that does not incorporate the face value of the bonds in the portfolio.

In reality, these figures change as the fund manager is constantly selling and buying bonds, but they are a helpful snapshot about return potential and income distributions.

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The annualised, or historic yield, calculates what a bond fund has paid out over the past 12 months, expressed as a percentage based on the current value of fund.

Yields on funds that invest in shares are historic yields. They take into account the past 12 months' dividend payments and express them as a percentage of the price of the fund, giving an annual income figure based on past payments. They are backwards-looking, so provide a good snapshot of a portfolio, but are not a forecast for the income payments over the next 12 months.

When looking at bond fund factsheets, the distribution yield is probably the most useful as it gives the best indication of the income payments you’ll receive, which is one of the main reasons to own bonds.