The stellar returns that junk bond funds are generating are unsustainable and will come to an end, fund managers and financial advisers agree, but they disagree on when that will be.
Year-to-date through last Monday, junk bond funds had risen 19.9%, behind only bank loan funds (up 21.1%) among all fixed-income funds, according to Morningstar Inc. of Chicago.
“It's been a great run, but let's not anticipate this will continue,” said Mark J. Vaselkiv, lead portfolio manager for global high-yield strategy and a vice president at
T. Rowe Price Group Inc. of Baltimore. “The market is due for a pause.”
A pause, however, suggests that the market will continue to produce solid returns.
Given that a relatively high de-fault rate is anticipated, that seems to be a risky bet, said Lewis J. Altfest, president of New York based L.J. Altfest & Co. Inc., which manages about $400 million in assets.
“I have not been a buyer of the high-yield corporate market,” he said.
DRAGGED DOWN
But the junk bond default rates anticipated by Moody's Investor Service and Standard & Poor's, which are expected to exceed 15%, are probably overdone, said Michael Weilheimer, co-director of high-yield investments and vice president at Eaton Vance Management of Boston. Both ratings agencies are based in New York.
That is partly because the market collapse was so swift and severe that it dragged relatively big companies into junk status, said Mr. Weilheimer, co-manager of the $1.69 billion Eaton Vance Income Fund (EVIBX) and the $324 million Eaton Vance High Income Opportunities Fund (ETHIX).
Those companies have “more tools to survive” than smaller companies, he said.
That doesn't mean that Mr. Weilheimer thinks that high-yield-bond funds will continue to generate torrid returns. But their returns will continue to impress, he said.
“Our view is, you're going to see 15%-plus returns over the next couple of years,” Mr. Weilheimer said. “Where we see the value on a risk-adjusted basis is in the middle tier.”
Such bonds tend to have a B rating, Mr. Weilheimer said.
That is a popular place for junk bond fund managers to be.
It is where Houston-based Peter Ehret, head of high yield for
Invesco Worldwide Fixed Income, a unit of
Invesco Global Asset Management NA Inc. of Atlanta, also sees value.
UNDERWEIGHTING RISK
“I think we have been trying to maintain an underweight to the market's riskiest stories,” he said.
That has led him to look to “the middle of the market,” said Mr. Ehret, lead manager of the $605 million Aim High Yield Fund (AMHYX).
He said he is a little more optimistic than some other managers about what returns junk bonds will throw off in the near future.
“I wouldn't be surprised if high yield goes through a rough period,” Mr. Ehret said.
But the “huge rally” that high-yield bonds have seen was the result of the market's being beaten down to unheard-of levels, he said.
That means that though junk bonds have rallied, there is still room for them to gain, Mr. Ehret said.
But there isn't a lot of room, said Charles Lieberman, a strategist and chief economist with Advisors Capital Management LLC, a Paramus, N.J.-based firm with $250 million in assets.
“It's hard to sustain those kinds of returns,” he said about recent junk bond returns.
They won't give back their gains, but “the incremental returns are going to be lower,” Mr. Lieberman said.
That is bad news for high yield, but it may actually be a good sign for the market.
“The high-yield market may be forecasting the
recession is over,” Mr. Vaselkiv said. “Typically, it's a pretty good leading indicator.”
Of course, things could change; the market could falter, and defaults could rise.
Mr. Vaselkiv doesn't think those things will happen, but T. Rowe Price does take a more cautious view of the high-yield market than most asset managers, he said.
BANK LOANS
For example, about 11% of the $5.35 billion T. Rowe Price High-Yield Fund (PRHYX) is invested in bank loans, Mr. Vaselkiv said.
Bank loan funds are senior loans, meaning that should the company default, these loans take precedence over other debt and have to be paid back before bondholders get paid.
For example, even though General Motors Corp. of Detroit filed for bankruptcy protection last week, it said that it will redeem its bank loans at face value, Mr. Vaselkiv said.
E-mail David Hoffman at [email protected].
