A way of measuring the annual income payments made to unitholders, by an A-REIT or an ETF, as a percentage or portion of its unit price
Written byCFI Team
What is Distribution Yield?
Distribution yield is defined as a way of measuring the annual income payments made to unitholders, by an A-REIT or an ETF, as a percentage or portion of its unit price. It is used as a measure of income relative to the size of an investment.
Distributions are similar to dividends. They are commonly received by individuals or investors with investments in exchange-traded funds (ETFs) and/real estate investment trusts (REITs). A distribution can be defined as a portion of the profits generated by a trust or a fund, which is distributed to unitholders or investors, and an income payment. It is one method of making money from investment classes (ETFs and REITs). The capital gains and distributions made from the investments ideally make up an investor’s total return.
Summary
- Distribution yield is defined as a way of measuring the annual income payments made to unitholders, by an A-REIT or an ETF, as a percentage or portion of its unit price.
- Distributionyieldis used as a measure ofincome relative to the size of aninvestment.
- It is important to note that a distribution yield is based on a fund’s past performance and that the yield computations do not include or make any projections for future performance.
Calculating the Distribution Yield
The formula below shows how the distribution yield can be calculated:
The distribution yield equation makes use of the recent distribution and multiplies the amount by 12 to produce an average annual return. The annualized sum is then divided by the net asset value (NAV) at the end of the period to estimate the yield of the distribution. The end of the period can be the end of the month and the distribution can include a capital gain, gains in the form of interest received, or the declaration and receipt of a special dividend. Distribution yields on annuities and fixed income portfolios can serve as a proxy for cash flow comparisons and analysis.
It should be noted that a distribution yield is based on a fund’s past performance and that the yield computations do not include or make any projections for future performance. The distribution yield, therefore, does not provide concrete information on what a bond fund will produce from the time it is purchased or invested in, to the time that it is sold off.
Distributions that consist of recurrent dividends and interest tend to be more accurate in comparison to distributions with irregular payments. Excluding irregular distributions or payment may result in lower distribution yields, although the inclusion of the payments can also distort the yield calculated.
Furthermore, although distribution yields provide investors with highlights for income payments, the variables associated with special dividend payments and capital gain distribution may provide skewed returns. It is why investors find the sum of the distributions over the recent 12-month periods and divide the sum by the NAV at the time of computation to find the true or more reliable yield.
Drawbacks of the Dividend Yield Computation
The dividend yield computation does come with a few drawbacks. One of the first challenges to be mindful of is the fact that the calculation is based on the assumption that the last 30-day income multiplied by 12 will result in the 12-month returns. Although the sum-product may provide a good estimate and picture of the returns gained over the 12-month period, it is not always the same and the actual returns made may differ.
Secondly, the computation assumes a 30-day month; however, not all months have 30 days. It can affect the accuracy of the calculation. One example can be the days in the month of February. February normally has 28 days and 29 days on a leap year. Months like August have 31 days. The variation in actual lengths of a month may result in a skewed distribution yield. The difference will not be significant, but it does have an impact.
Furthermore, another assumption of the distribution yield computation is that the net present value is an average NAV of the last 12 months. It is not always the case.
SEC Yield vs. Distribution Yield
The SEC yield is relevant to companies that fall under the jurisdiction of the Securities and Exchange Commission (SEC) and the figure is to be reported to the SEC. Following an assumption that an investor holds each bond in a portfolio to maturity, the SEC yield is used to provide an estimate on the yield an investor is expected to receive. Moreover, the yield follows an assumption that the income made will be reinvested, and it also accounts for expenses and fees.
It is argued that the SEC may provide more accurate results in comparison to the distribution yield and the calculation displays more month-to-month consistencies. Both calculations show past performance and not future performance, and the calculations both follow assumptions that may result in skewed results. However, the SEC yield is standardized, which allows investors to easily make comparisons.
More Resources
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:
