Investor money is flowing into junk, or high-yield, bond mutual funds.
These bonds were punished by the subprime lending crisis this summer, but investors have since been lured back by their returns.
Last month's interest-rate cut by the Federal Reserve made their yields more attractive than those of more conservative bond choices. Although a few big junk bond deals have fallen through, Wall Street has plans to deliver several new ones by year's end, providing greater choices.
Portfolio managers of high-yield funds, made up of bonds with less-than-investment-grade ratings, are taking fewer risks these days. They're avoiding anything to do with housing, for example.
One sure sign junk bonds are back in business is that the Securities and Exchange Commission is looking into possible illegal insider trading in them. Worry about misuse of confidential corporate information only becomes a hot topic when a market is hot enough to merit such hijinks.
But there's still that troublesome name to contend with: Anything called junk doesn't exactly evoke trust.
"We say it isn't politically correct to call them junk bonds anymore," said Andrew Feltus, manager of Pioneer High Yield Fund and Pioneer Global High Yield Fund, two of the top-performing high-yield funds. "I tell people high yield is a 'satellite' asset class that you want to be in and that you want to add to when they get really cheap."
His $4 billion Pioneer High Yield "A" (TAHYX) has a 12-month return of 12 percent and three-year annualized return of 9 percent. The $2 billion Pioneer Global High Yield (PGHYX) has a 12-month return of 9 percent and a three-year annualized return of 10 percent.
Though primarily a high-yield bond fund, Pioneer High Yield has 14 percent of its portfolio in stocks. Both of the Pioneer funds require a 4.5 percent "load" (initial sales charge) and $1,000 minimum initial purchase.
"Since junk bonds are those rated below investment grade, the description scares a lot of people," said Mary Austin, portfolio manager of Pax World High Yield Fund, another top performer. "But when I look at our numbers, we're a mutual fund portfolio that is less risky than an equities portfolio."
Many investors don't take the time to understand what high-yield bond funds actually offer, she said. She considers them an excellent portfolio diversifier and especially good for retirees because they provide good income.
Her $92 million Pax World High Yield Fund (PAXHX) has a 12-month return of 9 percent and three-year annualized return of 8 percent. This no-load fund requires a $250 minimum purchase. About a quarter of the portfolio consists of foreign bonds, with a special emphasis on emerging-market telecommunications companies.
"High-yield funds had put together a solid string of monthly returns until late summer, when the subprime crisis went into full swing and corporate credit came under severe pressure," said Jeff Tjornehoj, senior research analyst with Lipper Inc. in Denver. "Investors really laid off the gas pedal and junk bonds sank, but since then people have realized they still want yield and the funds bounced back strongly."
Spreads between high-yield and other bonds have widened appreciably and are likely to stay that way through year-end and for some time, Tjornehoj said. That's why investment advisers are singing the praises of high-yield bond funds to their clients.
"I absolutely use high-yield bond funds and have dumped intermediate-term bond funds over the past month and a half to move into them," said Angela Thomson, certified financial planner and principal with Coastal Financial Planning Inc. in Lincoln, R.I. "There's not a lot of downside risk because money managers burned in the dot-com era learned their lesson and portfolios aren't as risky as 10 years ago."
High-yield bonds should comprise only about 5 percent to 10 percent of an individual's overall portfolio because they don't provide a lot of growth, Thomson said. For that reason she doesn't put them in the portfolios of young people.
"With a high-yield bond you're basically protecting yourself with yield," she said.
Two of her favorite high-yield funds for clients are Fidelity Advisor High Income Advantage Fund and Julius Baer Global High Income Fund. She likes the deep research resources of Fidelity but would probably go with the global fund because that's where the greatest opportunities are now.
The $3.4 billion Fidelity Advisor High Income Advantage (FAHDX) has a 12-month return of 13 percent and a three-year annualized return of 12 percent. It requires a 4 percent load and $2,500 minimum investment. Seventeen percent of its portfolio is in stocks.
The $230 million Julius Baer Global High Income (BJBHX) has one-year and three-year annualized returns of 9 percent. This no-load fund requires a $1,000 minimum.
"In some ways, high-yield bonds are like stocks that pay high dividends," Feltus said. "If the market is rallying, you'll do just fine and there will also be a nice dividend stream to help you ride out any bumps."The underlying fundamentals of high-yield bonds are still strong and so are the U.S. and global economies, Feltus said. Nonetheless, he's avoiding any of the bonds issued in the housing or consumer discretionary sectors because he still considers their prospects to be troubling.
Andrew Leckey answers questions only through the column. Address inquiries to Andrew Leckey, P.O. Box 874702, Tempe, AZ 85287-4702, or by e-mail at [email protected].