How can a bond fund have a higher current yield than the bonds it contains?

Question

I'm looking for a place to park funds for a 1-3 year period, which rules out stocks.

I found SFHY, a short term corporate bond fund, which has a current quoted yield of 4.33% and a "YTD Daily Total Return" of 3.05%. That sounds ok, as it will at least do better at keeping up with inflation than a so-called high yield savings account or CD. However, since unlike an individual bond the fund doesn't have a maturity date and presumably rolls over into new bonds from time to time as existing bonds mature, this still has interest rate risk so I thought I would look at the individual holdings to see if any of them would be suitable.

I tried to look up all the bonds showed in the top ten holdings, which amount to nearly 25% of the fund's holding. Some of them I couldn't find, such as "Tenet Healthcare Corporation 5.13%" - I found the 6.75% issue for the same company though. But all of the ones I did find had yields of less than 3%. Maybe the remaining 75% magically have much higher current yields based on the fund price, but I doubt it. If I run a screen for corporate bonds in general, the highest yields I find for short terms bonds (3 Years or less) on the secondary market top out at just under 2%!

Since this is a fund that trades on the market, I would expect the value of the fund itself to change based on interest rates, and more accurately, on the actual market value of the underlying bonds. For instance, the "Tenet Healthcare Corporation 6.75%" is actually only yielding around 1.9% so I would expect that this fund would get bid up appropriately so that the portion of this bond in the fund actually pays 1.9% to anyone buying this fund.

I found this old question but it seems to be asking about annualized performance over several years, where in the above case I would assume that the quoted yield is no more than 6 months old, since it should reflect at worst the last payment, although in fact I would expect it to be more up to date unless the fund is churning a lot since it's easy to extrapolate based on the last payout and unlike dividend payments the coupon amount is fixed for the life of the bond. Furthermore, I don't know how often the fund itself turns over due to matured bonds, but I can't imagine that would be more than every six months either. And I would also expect that new bonds would have coupons close to the yields of the maturing bonds so that there wouldn't be much change there. If anything, rates have actually risen slightly in the past 6 months, so I would expect a lagging yield to be lower than current actual yield.

So what's going on here? How is the fund seemingly paying out nearly twice the yield of the bonds it owns?

Answer 1

I think you're mixing up current yield, coupon rate and yield (which is typically defined as "yield to maturity").

The stated rate on a bond (e.g. the in "Tenet Healthcare Corporation 5.13%") is just the coupon rate and is a fixed percentage of the redemption amount (i.e. if you buy 10 bonds with a par (redemption) value of $1,000 each you'll get 5.13%/4 * 10 * 1,000 = 128.25 every quarter). The current yield is just the coupon amount divided by the price, and can be very different than the yield to maturity. It's not uncommon for bonds from the same issuer with different coupon rates to have the same "yield" (the difference is accounted for in the prices of the bonds).

Since a bond ETF doesn't mature, the "yield" is simply a function of the change in value and the interest it pays out. It's possible for a bond fund to pay more or less in interest than the bonds it holds. Paying more coupons that its bonds would obviously dilute the price, but they may plan to make up for it with higher-yielding bonds in the future.

Answer 2

Total return includes coupon payments and capital gains/losses. The fact sheet [PDF] for this fund shows that it is a short-duration junk bond fund.

Junk bond prices move around a lot, so the capital gains/losses will likely be a significant component of total return. A bond fund would have capital losses if the price of bonds goes down.

Further, the YTD returns would be only a half-year's worth of total returns, as we are in June. Comparing a YTD return to an annualized yield, as you seem to be doing, is not apples-to-apples.