[1]

The Division of Investment Management’s Disclosure Review and Accounting Office (DRAO) is responsible for reviewing Fund disclosures. As part of this effort, the staff has observed differences in how TIPS Funds calculate their standardized yield, referred to as “SEC Yield.” The staff is concerned about potential investor confusion about TIPS Funds that, during periods of rising inflation, report exceptionally high SEC Yields that vary significantly from month-to-month and may not be repeated.

TIPS are notes and bonds issued by the U.S. Treasury that provide protection against inflation.[2] The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. This principal adjustment is designed to keep the principal constant on an after-inflation or real basis. TIPS pay interest at a fixed rate, but because the rate is applied to the adjusted principal, the amount of interest may vary over time. If inflation occurs, the interest payment increases. If deflation occurs, the interest payment decreases. When a TIPS matures, investors are paid the adjusted principal or original principal, whichever is greater. As discussed below, the inflation adjustment to principal feature of TIPS may result in TIPS Funds disclosing exceptionally high SEC Yields during periods of rising inflation.

Funds are not required to disclose their yield. However, when they do, the federal securities laws provide a standardized way for Funds to calculate their yield for advertising purposes.[3] This SEC Yield was created so that investors could more easily evaluate the yields of comparable Funds.[4] Specific instructions for calculating SEC Yield are provided in Rule 482(d)(1) under the Securities Act of 1933 (the “Securities Act”) and Item 26(b)(4) of Form N-1A. The SEC Yield approximates the current income generated by the securities in a Fund’s portfolio over a historical 30-day period after the deduction of expenses, and is shown as an annualized percentage of the Fund’s offering price.[5]

If a Fund discloses its SEC Yield there are other disclosure requirements designed to provide broader context.[6] If a Fund discloses its SEC Yield, it must also disclose its standardized total return and a legend explaining that the performance data quoted represents past performance that does not guarantee future results.[7] Even so, in the staff’s view, Funds also may need to provide additional disclosure when promoting the sale of Fund shares based on the SEC Yield during certain market conditions where it could be misleading without such disclosure.[8]

The TIPS inflation adjustment to principal is not explicitly addressed in the SEC Yield calculation methodology, which was adopted before TIPS existed.[9] This has resulted in Funds adopting different treatments of the inflation adjustment to principal when calculating SEC Yield. Some TIPS Funds appear to exclude the inflation adjustment to principal from the yield calculation. Others appear to include this adjustment as income for purposes of the yield calculation. This diversity of practice among funds in how they calculate SEC Yield has led to significant differences in the yield advertised by similar TIPS Funds for the same periods.

The staff strongly encourages TIPS Funds that choose to advertise their SEC Yield to evaluate which calculation methodology it believes is most informative to investors. While the staff believes both approaches are consistent with the prescribed calculation methodology, excluding the inflation adjustment to principal as income omits a key feature of TIPS and a potentially significant contributor to yield. On the other hand, the staff believes that TIPS Funds may need to provide additional disclosure when including the inflation adjustment to principal as income during periods of rapidly changing inflation. Under this approach, the SEC Yield will be higher during periods of rising inflation. Given the SEC Yield calculation looks back only 30 days and is then annualized, the yield may vary significantly from month-to-month, particularly during periods of rapid change in the rate of inflation. Under certain circumstances, including in the recent market environment where inflation has been higher than in recent years, this may also cause the SEC Yield to be exceptionally high and may be unlikely to be repeated.

When promoting the sales of TIPS Funds based on the SEC Yield that includes a 30-day inflation adjustment, the staff believes that TIPS Funds may need to explain to investors that this adjustment may cause the yield to vary substantially from one month to the next.[10] If sales literature includes an exceptionally high SEC Yield for a TIPS Fund, in the staff’s view, the sales literature should disclose that the yield is attributable to the rise in the inflation rate because the inflation adjustment to principal is treated as income. The staff believes that the TIPS Fund should also disclose that this 30-day inflation adjustment may cause the SEC Yield to vary substantially from one month to the next and might not be repeated.[11] In the staff’s view, these explanations should also be tailored to the circumstances and current market conditions faced by the TIPS Fund rather than boilerplate disclosures.

Alternatively, to address concerns about the volatility of the SEC Yield when including the inflation adjustment to principal as income, the staff will not object if, instead of including the inflation adjustment over the prior 30-day period and annualizing it, a TIPS Fund uses an inflation adjustment that looks back over the prior 12-month period.[12] However, to use the prior 12-month period, a TIPS Fund would need to disclose that the SEC Yield reflects the impact of inflation over the prior 12-month period, which is treated as income. Using this 12-month inflation adjustment may reduce the volatility of the SEC Yield from month to month.

Finally, financial intermediaries often include data feeds into their own websites that includes certain Fund information, including SEC Yield. The staff believes that financial intermediaries that post the SEC Yield prepared by TIPS Funds should also include any accompanying disclosures prepared by the Funds. The likelihood of investor confusion exists regardless of whether the information is posted by the Fund or a financial intermediary.

We hope that this ADI will assist registrants in preparing their filings. We also welcome feedback on this guidance and on any disclosure matters. If you have any questions or feedback, please contact:

Disclosure Review and Accounting Office

Phone: 202.551.6921

Email: IMDRAO@sec.gov