Why do you think they call it junk?
That`s a question to be pondered by American investors tossing record sums of money into high-yield, low-grade ”junk bond” funds. The quality of bonds in such funds has been declining this year–at the very time assets have nearly doubled to $20 billion.
Junk bonds are big moneymakers for Wall Street. Michael Milken of Drexel Burnham Lambert Inc., who was influential in popularizing junk bonds, recently debuted on the Forbes magazine list of 400 richest Americans with a net worth of more than $500 million.
Featuring yields of more than 10 percent, junk bond funds will look particularly good under tax reform`s lower individual brackets and are expected to attract even more investor dollars.
”There certainly are delinquencies and bankruptcies, since those are the sort of companies that high-yield funds invest in,” said Jack Utter, portfolio manager of IDS Extra Income Fund, which has this year`s highest total reinvested return of 15.45 percent. ”Quality of bonds overall is somewhat lower and riskier this year because more of them represent smaller companies carrying greater debt.”
The industrywide default rate on low grade-bonds is less than 2 percent, though some brokerage firms such as Prudential-Bache Securities and Merrill Lynch & Co. have logged considerably worse records with bonds they`ve underwritten. The rationale behind investing in a fund is that it`s made up of many bonds, thus blunting the possibility of major financial disaster.
IDS Extra Income, for example, has 60 percent of its portfolio in lower-grade bonds rated BB or below. But default in any one bond simply would decrease overall yield, not the big problem that befalls one investor holding one bond in default.
So the aggressive nature of the funds continues.
”When the market was overreacting to the Chernobyl nuclear incident, we were busy buying bonds of Long Island Lighting and Consumers Power,” said William Veronda, who manages Financial Bond Shares–High Yield Portfolio.
Fidelity High Income Fund has done particularly well this year with bonds of BCI Holdings (in the leveraged buyout of Beatrice Companies Inc.), as well as Macy`s.
”The LTV Corp. bankruptcy put the kibosh on high-yield funds and a considerable amount of money was withdrawn by investors, but they`ve came back strong again in October because of their yields,” said William Pike, portfolio manager of Fidelity High Income. ”The fund strategy is that your
`home runs` should offset your defaults.”
When considering a junk bond fund, check out the diversity of its holdings and track record of the investment firm offering it. Junk bond funds have easily outperformed high-grade bond funds, but the quality of the individual fund`s management makes the biggest difference.
The top five taxable high-yield bond funds through the first nine months of 1986, according to Lipper Analytical Services, are:
— IDS Extra Income Fund, IDS Financial Services, Minneapolis, Minn., a load fund (meaning it requires an initial sales charge); up 15.49 percent in total reinvested return including price appreciation; 10.25 percent current yield.
— First Investors Special Bond Fund, First Investors Management Co., New York, load; up 14.34 percent in total reinvested return; 11.40 current yield. — Financial Bond Shares–High Yield Portfolio, Financial Programs, Englewood, Colo., no load; up 13.38 percent in total reinvested return; 11.3 percent current yield.
— Fidelity High Income Fund, Boston, Mass., no load; up 13.28 percent in total reinvested return; 11.2 percent current yield.
— Investment Portfolio–High Yield, Kemper Investments, Chicago, no load; up 13.24 percent in total reinvested return; 9.88 percent current yield.
