Determinants of Yield

Most individuals shop for yield because the measure indicates how much monthly income can be expected. The same factors that affect yields on open-end bond funds influence yields on their closed-end relatives. In addition, the size of the discount or premium and the form and degree of leverage (if used) play a role. Thus, key variables affecting yield include the following:

• Portfolio expenses: Funds make distributions after subtracting expenses, including management fees and interest cost (if leveraged). Higher expense ratios lead to lower yields, other things equal.
• Average portfolio duration: Duration measures a fund’s sensitivity to interest-rate changes. Assuming an upward sloping yield curve (longer-term bonds yield more than short-term bonds), funds with lengthier durations or maturities generally yield more but carry greater “interest-rate risk.” When rates increase, the prices of bonds with longer durations tend to decline more than their shorter duration counterparts.
• Quality of holdings: Less creditworthy bonds normally produce higher yields, but also expose investors to more risk. Increasing credit concerns depress such bonds.
• Size of coupons: Higher coupon bonds typically yield more. Yet they often face greater “call risk” than lower coupon issues so a high yield may not be sustainable. Early calls become more common during times of declining interest rates.
• The discount or premium: The deeper a fund’s discount, the more its yield on market price exceeds its yield on net asset value.
• Leveraging: Under normal conditions, the return from the bonds held exceeds the cost of leverage, thereby amplifying yield. Leverage poses added risk if problems arise due to rising interest rates or increasing credit risk.