Junk bond funds are beginning to look more attractive to investors, even though their returns haven't been impressive.
For the week ended July 30, high-yield-bond funds reported $153.2 million of net inflows, according to AMG Data Services of Arcata, Calif. The prior week, the funds reported $26.4 million in net inflows.
The flows may indicate the reversal of a trend.
High-yield-bond funds reported $70.6 million of net outflows for the week ended July 16 and $45.2 million in outflows the prior week, according to AMG.
It is an interesting reversal given that junk bond funds as a category remain among the worst-performing fixed-income categories, according to Morningstar Inc. of Chicago.
Year-to-date through Aug. 4, junk bond funds had fallen 3.77%.
The Lehman Brothers U.S. Aggregate Bond Index, which measures the broad bond market, was up 0.96% during the same period.
LOW INTEREST RATES
The recent interest in junk bond funds may be a result of the low-interest-rate environment.
"I think it has to do with the hunt for yield," said Jeff Tjornehoj, a Denver-based analyst with Lipper Inc. of New York.
Three of the most respected high-yield funds — the $7.91 billion Pimco High Yield Fund, from Pacific Investment Management Co. LLC of Newport Beach, Calif.; the $5.31 billion T. Rowe Price High Yield Fund, from T. Rowe Price Group Inc. of Baltimore; and the $8.82 billion Vanguard High-Yield Corporate Fund, from
The Vanguard Group Inc. of Malvern, Pa. — are all yielding about 8%, according to Morningstar.
That isn't a bad yield when 10-year U.S. Treasuries are offering about 4%.
The extra yield being thrown off by junk bonds is likely just enough for some investors to feel that they are being properly compensated for the extra risk, said Charles Lieberman, strategist and chief economist with Advisors Capital Management LLC, a Paramus, N.J.-based firm with $250 million in assets.
It may be the right call considering that corporate bond spreads, a measure of perceived risk, have widened considerably, he said.
Corporate spreads have im-proved so much that Mr. Lieberman said that he would consider buying high-yield bonds.
"I think it does make sense," he said.
J. Michael Martin, president at Financial Advantage Inc., a Columbia, Md.-based firm with $260 million in assets, isn't so sure. "For people who are willing to be early, maybe it's time," he said.
"But as a firm, we haven't reached that conclusion yet," Mr. Martin said. "We think there might be more shoes to drop, and spreads will probably get wider."
He may be right.
"We have been somewhat hesitant to sound the all-clear with respect to high yield," said Paul Herbert, an analyst with Morningstar, explaining that even if the markets manage to avoid more shocks, it seems likely that defaults will continue to rise.
DEFAULT SURGE
A July 29 report from Standard & Poor's of New York backs him up.
"Given the prevailing high levels of market volatility, a material risk remains that defaults could be significantly more pronounced and severe," according to the report.
There were 37 defaults in the first half of the year alone, compared with 16 for all of 2007 and 22 in 2006, according to the report.
If six additional defaults through July 28 were included, the total for the year would easily exceed the total in the two prior years.
Such numbers illustrate the importance of understanding the strategy of any fund in general, and high-yield funds in particular.
For example, the poster child of the credit crunch that hurt so many investors is the Regions Morgan Keegan Select High Income Fund, offered by Morgan Keegan & Co. Inc., a Memphis, Tenn.-based subsidiary of Regions Financial Corp. of Birmingham, Ala.
That fund finished last year down 59.7%, placing it in the 99th percentile of its high-yield-bond-fund category, according to Morningstar. That is a precipitous fall from 2006, when it returned 11.1%, placing it in the 25th percentile of its category.
Luckily, the fund appears to have been something of an anomaly, Mr. Herbert said. "There's nothing even close," he said.
E-mail David Hoffman at [email protected].
