Understanding running yield to Make Better Decisions

By: Emma Pretorius, Head of Investor Relations for Amplify Investment Partners

Emma Pretorius

Comparing quoted yields of different funds is not as simple as it may seem, and there is a misconception that the quoted yield directly represents a fund’s anticipated return.

Understanding yield information is an important tool to assess a fund’s exposure to specific risks, and the extent of risk it undertakes.

To do this, it is critical to understand the running yield, or current yield, measures the income generated by a income-generating asset such as bonds or dividend-paying stocks, expressed as a percentage of the asset’s current market price. In the case of a bond, the running yield is calculated by dividing the annual coupon rate by the current market price times 100.

What running yield doesn’t tell you

Despite its utility, running yield has limitations that investors should be aware of. Firstly, it only accounts for the income generated by a fund’s holdings relative to the current market price, disregarding total return. It ignores the potential for capital appreciation or depreciation of underlying assets, so funds with higher running yields may have lower potential for capital appreciation, and vice versa. Focusing solely on running yield may cause investors to miss out on the overall potential return from both income and capital appreciation.

Moreover, the quoted yield assumes a stable interest rate environment, neglecting the impact of interest rate movements on yield and overall performance. The market price of income-generating assets can be volatile, potentially misrepresenting the fundamental value of an investment. A sudden drop in the market price can lead to a higher running yield, making the investment appear more attractive than it is.

It is critical to recognise that running yield is a point in time estimate, subject to change.  Portfolio managers may adjust the composition of the fund, selling low-yielding instruments and acquiring high-yielding instruments based on market conditions.

Additionally, the composition of a fund, specifically its exposure to fixed or floating rates securities, plays a pivotal role. A fund with more fixed rate exposure can be more susceptible to changes in yield than one with more floating rate exposure as fixed and floating rate securities respond differently to interest rate changes.

  • If interest rates rise, newly issued fixed rate bonds will offer higher coupon rates, making existing bonds with lower coupons less attractive, and their market price could decrease, leading to a potential increase in a fund’s running yield. If interest rates fall, the market price of existing fixed rate bonds could rise, leading to a potential decrease in the running yield.

Funds with higher exposure to floating rate securities, are more insulated from interest rate changes. Floating rate securities’ coupon rates are reset periodically based on a benchmark interest rate, so when interest rates rise, the coupon payments on floating securities increase, helping to mitigate the impact of rising rates on running yield.

  • The running yield of a fund is also influenced by duration in that it can be more susceptible to change if it has higher duration (a measure of sensitivity of a bond’s price to changes in interest rates). The longer the duration, the more a bond’s price is likely to change in response to interest rate fluctuations, which leads to greater variation in a fund’s quoted yield.

Running yield should therefore not be the sole basis for investment decisions because of what it doesn’t tell you. It doesn’t provide a complete picture of an investment’s overall risk and return profile. Running yield is subject to liquidity risk (higher running yields may indicate that the underlying investments are less liquid), credit risk (higher running yields may indicate that investments with lower credit ratings and higher credit risk, and bonds with higher yields often belong to issuers with weaker credit quality), and interest rate risk (the running yield does not account for changes in interest rates, which can significantly affect the value of fixed income investments).

What yield does tell you

Comparing income funds with similar yields and different durations can provide a good picture of how each fund is positioned and what risks, and how much risk, they are exposed to. A fund with low duration would need to have exposure to more credit and liquidity risk to generate a higher yield.

The below table reflects the duration and quoted yield of three different income funds, each yielding more or less the same. By comparing these numbers, you can get a good idea of how each of these funds are positioned and what risks, as well as how much risk the funds are exposed to.

Key takeaways:

Fund A has the lowest duration, but a similar yield to Fund B and C. In order to achieve a similar yield to that of its peers with much less duration, it must have exposure to more credit and liquidity risk. It would be safe to assume that fund A is taking on more credit risk to generate the higher yield. Understanding what running yields do and don’t tell you, and why a quoted yield is not the same as actual return, are therefore extremely valuable tools to assess the risks funds undertake and are exposed to and help to inform better investment decisions.

*Sanlam Collective Investments

Disclaimer

AMPLIFY INVESTMENT PARTNERS (PTY) LTD IS AN AUTHORISED FINANCIAL SERVICES PROVIDER (FSP 712).

Sanlam Collective Investments (RF) (Pty) Ltd (“SCI”) is a registered and approved Manager in terms of the Collective Investment Schemes Control Act. Collective investment schemes are generally medium- to long-term investments. Past performance is not necessarily a guide to future performance, and the value of investments/units /unit trusts may go down as well as up. A schedule of fees and charges and maximum commissions is available from the Manager on request. Collective investments are traded at ruling prices and can engage in borrowing and scrip lending. The Manager does not provide any guarantee with respect to either the capital or the return of a portfolio. The manager has the right to close the portfolio to new investors in order to manage it more efficiently in accordance with its mandate. Income funds derive their income primarily from interest-bearing instruments. The yield is current and is calculated on a daily basis. If the fund holds assets in foreign countries, it could be exposed to the following risks regarding potential constraints on liquidity and the repatriation of funds: macro-economic, political, foreign exchange. The Manager retails full legal responsibility for the co-brand portfolios. Collective investments are calculated on a net asset value basis, which is the total market value of all assets in the portfolio including any income accruals and less any deductible expenses such as audit fees, brokerage and service fees. Forward pricing is used. Performance is based on NAV to NAV calculations with income reinvestments done on the ex-div date. Performance is calculated for the portfolio and the individual investor performance may differ as a result of initial fees, actual investment date, date of reinvestment and dividend withholding tax.

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