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Saturday, 16 July 2011

Vanguard Bond Fund Yields 15% for 2010-11

According to Vanguard's website, the Vanguard Index Diversified Bond Fund paid distributions of 15.52 cents per unit in 2010-11. Given that the price of a unit now is $1.01, this equates to an annual distribution yield of around 15 per cent. This is significantly higher than the 5% distribution yield that I am used to, so I began to wonder why bonds did so well last financial year. I am not one to reinvest managed fund distributions and instead have spent the money on buying new running shoes (I will write a post about my shoes later).

It turns out that I am not the only person who noticed this massive distribution on the bond fund. Over at the Bogleheads forums, there is a forum post about the bond fund's massive distribution payout, as well as an associated massive drop in unit prices. The Bloomberg chart below shows the extent of this fall in unit prices.

A Bogleheads member named Tonens gives the following explanation for the anomoly, saying that the large distribution was the product of the strong Aussie dollar.

... [T]he Vanguard Diversified Bond fund is 60% International Bonds, with that proportion hedged to the Australian dollar. The hedging gains as the Aussie dollar appreciated over the last year rather than interest earned likely accounted for the majority of that large distribution.

The total distribution for the fund over the last 12 months its close to 16c (ie about 16%). If the currency goes the other way, it'll contract accordingly.
Another member named Asset Chaos explains why the unit price colapsed:
I think you'll find that the price of a unit of diversified bond is not constant. It fluctuates daily in line with the market prices of the bonds held in the fund. The reason that the unit price drops after a distribution is the fund gets paid some interest on its bonds on many days in between the dates on which the fund distributes this income to the unit holders. That accumulating interest is an asset of the fund and so is reflected in the unit price, which is just the total value of the fund divided by the total number of units outstanding. When the fund distributes the interest income, that money is no longer in the fund, so the fund's value drops suddenly on the distribution date. But you as a unit holder still have the same value: you've got a unit's worth of value still in the fund plus the value of the distribution, which you have in the form of cash in hand or in the form of additional units.
It worries me when an investment pays out large distributions accompanied by a fall in unit prices. This is because the fund may be paying for the distributions by eating up capital. However, the explanation that the massive distribution payout is the product of the strong Aussie dollar makes sense.

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