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I am trying to determine if all of the coupons of a bond ETF are paid out to investors as dividends, or if some of the income is used to purchase more bonds.

I am guessing that this is somewhat dependent on the particular ETF, but was wondering what is generally the case. The particular bond ETFs that I am interested in are tracking indices.

I couldn't find the information I was looking for in the prospectuses.

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In the US, they're usually not. The coupon payments from bonds underlying the ETF are usually paid out as distributions to investors. Investopedia's article on bond ETFs, as well as this ETF FAQ state that many bond ETF's pay coupon payments out as distributions on a monthly basis (quoted portion is from Investopedia):

Bond ETFs pay out interest through a monthly dividend, while any capital gains are paid out through an annual dividend.

ETF distributions aren't normally reinvested in the underlying fund automatically because this would incur additional commissions.

Some brokers offer an option to reinvest distributions, but the availability of this option depends on the broker, not the fund, so you won't find information about it in the prospectus. For example, Vanguard states on their ETF information page that investors looking to reinvest distributions from Vanguard ETF's should ask their brokerage firm if this is an option. iShares UK and Vanguard Canada also state that for individual investors, distribution reinvestment varies on a per-broker basis.

  • This is in the US, for tax reasons. In other places it may be different. – littleadv Jul 2 '13 at 19:31
  • @littleadv Right; I believe the story is the same for at least the UK and Canada, though, since reinvestment of distributions is done on a per-broker basis. – John Bensin Jul 2 '13 at 19:36
  • This is a different question, but why would capital gains be paid as dividends? – mushroom Jul 2 '13 at 19:39
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    @mushroom Technically, capital gains are paid as distributions, not dividends (dividends are also paid as distributions; the latter is just the more general category). The story is the same as for coupon payments. The additional cost from commissions of reinvesting in the fund usually means that the preferred strategy is paying capital gains in the form of cash distributions. – John Bensin Jul 2 '13 at 19:43
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    They may have to sell the bonds to maintain the statistics of the index. If you buy a fund that is supposed to be holding mostly long-term bonds, then bonds nearing their maturity may not replicate the index that well. There can also be bonds that can have principal adjustments that can be viewed as capital gains as well. – JB King Jul 2 '13 at 20:48

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