SEC Yield

The Larkfield Income Fund's advertisement shows a 30-day standardized yield of 3.85 percent. The fund's website separately promotes a "distribution rate" of 5.40 percent. What explains the gap, and which figure is the one prescribed for advertised yield?

1. A.The two differ only because one is annualized and the other is not, so either may be advertised.Wrong. Both are expressed on an annualized basis. They differ in WHAT is being annualized - net investment income versus total payouts.
2. B.The distribution rate is the prescribed figure, and the 30-day yield is a marketing metric the fund chose to add.Wrong - reversed. The standardized 30-day yield is the regulated figure; the distribution rate is the unregulated one.
3. C.The 30-day standardized yield follows a prescribed formula based on net investment income after expenses and is the required, comparable figure; a distribution rate is unstandardized and can include short-term gains or return of capital.Correct. Only the standardized computation is comparable across funds, which is why it is the one required in a yield advertisement.
4. D.The 30-day yield includes capital appreciation while the distribution rate excludes it.Wrong. The standardized yield deliberately excludes capital appreciation; it measures income after expenses.

Why: The 30-day standardized yield - often called the SEC yield - is computed under a prescribed formula from the fund's net investment income over the most recent 30-day period, after deducting expenses, and annualized. Because every fund must compute it the same way, it is comparable across funds, and it is the yield figure required in a fund performance advertisement. A "distribution rate" is not standardized: it simply annualizes what the fund recently paid out, and those payments can include short-term capital gains or even a return of the investor's own capital. A distribution rate can therefore look attractive while the fund's actual net investment income is far lower.

Two bond funds appear side by side on a platform. Hollowbrook Income Fund advertises a "distribution rate" of 7.2%. Aldermarsh Bond Fund advertises a 30-day standardized SEC yield of 4.8%. IAR Camille Okereke tells a client the two numbers are not comparable. Her best explanation is:

1. A.The 30-day standardized SEC yield is a prescribed, net-of-expense measure of what the current portfolio would earn to maturity and is comparable across funds, while a distribution rate merely annualizes the latest payout and may include realized gains or a return of capital.Correct. Only the standardized yield is computed under a uniform formula. A distribution rate can be supported by capital, so it may exceed what the portfolio actually earns.
2. B.The distribution rate is the more conservative of the two, because it reflects cash actually paid to shareholders.Incorrect. Cash actually paid is not the same as income actually earned. A distribution can be funded by realized gains or by returning the investor's own capital.
3. C.Both figures are computed under the same SEC formula, so the gap between them reflects only the credit quality of the two portfolios.Incorrect. A distribution rate is not standardized at all. Comparing it directly with a standardized yield is comparing two different measurements.
4. D.The standardized SEC yield includes expected capital appreciation, while the distribution rate excludes it.Incorrect. The standardized yield is an income measure only; it expressly excludes capital appreciation. Ironically it is the DISTRIBUTION rate that may include realized gains.

Why: The 30-day standardized yield is computed under a prescribed SEC formula, net of fund expenses, based on the income the portfolio's CURRENT holdings would generate if held to maturity. Because every fund must compute it the same way, it is designed for apples-to-apples comparison. A distribution rate is not standardized: it typically annualizes the most recent distribution and divides by the share price, and that distribution may include realized capital gains or even a return of the investor's own capital. A fund can therefore show a distribution rate well above what its portfolio actually earns, and sustaining it may erode net asset value over time.