The 30-day SEC yield is an annualized measure of the rate at which an ETF earns interest or dividends from its underlying holdings. It is calculated by taking the total interest earned in an ETF’s portfolio over the course of 30 days, subtracting any ETF expenses, and dividing by the maximum share price of the fund on the last day of that period to obtain a percentage value. This value is then annualized.
The 30-day SEC yield may not always match the rate that the ETF is distributing cash dividends. This is because ETFs pay out dividends for bonds based on their yields to maturity when the bonds enter the portfolio. If the prices of bonds were to decline, their yields to maturity would increase (this is simply because the future cash flows of the bonds remain the same, while the prices are now lower). The 30-day SEC yield would reflect the new (higher) yields, but the ETF would continue paying dividends based on the yield when it bought the bond.
An example may help make this more clear. Let’s consider a bond that was issued five years ago with a 2% annual coupon and an initial maturity of ten years. The bond will pay $100 in face value at maturity, and $2 in annual coupons along the way. If an ETF purchased the bond at par ($100) at the time of initial issue, the ETF will pay out $2 per year in dividends for this bond as long as the bond is in the ETF’s portfolio.
Now, imagine five years have passed and interest rates have increased, causing the bond price to drop to $95. Over the next five years of the bond’s life, the price will gradually converge to $100 (though the price may move both up and down along the way), meaning that there is an expected price appreciation of $1 per year. The SEC yield captures both the expected price appreciation and the coupon payments, and would be around 3% ($2 in coupons plus $1 in price appreciation per year, divided by a share price of $95). However, the ETF continues to pay $2 per year in dividends, a rate of just over 2%.
If this was the only bond in the ETF, holders of the ETF would see an SEC yield around 3% and a dividend yield of only around 2%. However, they are not “missing out” on anything - the remainder of the yield comes through the expected gradual increase in the price of the bond. This will be reflected in the price of the ETF holding the bond, and will show up in the total return of the ETF.
The rapid rise of interest rates in 2022 provided many examples of this phenomenon. The chart below daily prices for a bond originally issued in March of 2021 that matured on March 31, 2023. In 2021 through mid-2022, the price of the bond generally decreased to a low around $98 as expectations about interest rates rose. From mid-2022 until maturity on March 31, 2023, the price converged to the par value, ending at exactly $100.
Source: The 2-year treasury note with coupon rate of 0.125% and CUSIP 91282CBU4, as reported by the Intercontinental Exchange (ICE), displayed its mid-clean price ranging from March 23, 2021, to March 31, 2023.
As of August 2023, you could observe this effect in many ETFs. For example, the price of the iShares 0-5 Year High Yield Corporate Bond ETF (SHYG) decreased by about 8% from the end of 2021 to the end of July 2023. As of July 31, the 30-day SEC yield of SHYG was 7.98%. The dividend yield, calculated by dividing the $0.21 dividend paid on August 7th by the fund’s closing price of $41.68 and annualizing, was only about 6.05%. Looking at the holdings of the fund shows a similar gap: as of August 15, the average coupon rate of the bonds in the fund was 6.14%, while the average yield to maturity was 8.25%.
The opposite effect can occur if rates drop rather than rise. Funds holding bonds purchased before the rate drop will continue paying out dividends at the original rate, while the SEC yield will reflect the new, lower, yield to maturity. The most important thing to remember is that when there is a gap between the SEC yield and the dividend yield, holders of the fund are neither “missing out” nor getting anything extra. The full yield of bonds held by the fund will be realized through a combination of price change and cash dividends.
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