October 6, 2004

High-Yield Bond Funds -- Third Quarter 2004 Review

Yield Chasers Spark a Rebound

Oct. 4, 2004 -- Shareholders in mutual funds that buy high-yield bonds got a pleasant surprise in the third quarter.

The funds returned 3.6 on average, preliminary data from Standard & Poor's showed, after rebounding from the 0.8% loss they suffered between April and June. Through the first nine months of the year, the average junk bond fund was up 4.8%.

Earlier in the year, investors had feared that high-yield bonds and other fixed-income securities would be hurt as the Federal Reserve tightened monetary policy during 2004. That scenario played out in the high-yield market in the second quarter.

More recently, however, while the Fed was hiking short-term rates, the bond market was pulling long-term rates lower. The yield on 10-year Treasuries hovered near 4% in late September before climbing to 4.12% over the last two days of the month.

That encouraged yield-hungry investors to embrace junk bonds, whose yields have been averaging around 8% lately. Combined with a slowly improving economy and a choppy stock market, that created a healthy atmosphere for junk bonds.

"It's very difficult to find alternatives where you feel like you can garner a decent return on your money," said Scott Schroepfer, who manages the AXP High Yield Bond Fund/A (INEAX). "That kind of leads people to the high yield market, because of the yield."

Bond traders said the economy has been expanding fast enough to enable companies to reduce debts, thus boosting investors' confidence that junk bond obligations will be met. But the growth has not been so rapid that it makes stocks look more attractive or forces the central bank to hike rates sharply, fund managers said.

Adding to sound fundamentals of junk bonds, default rates have remained low.

Fund managers said, too, that investors' eagerness to buy junk bonds has picked up while issuance has turned higher lately.

Margaret Patel, who oversees Pioneer High Yield/A (TAHYX), said the number of new issues, although a bit better than in all of 2003, have been relatively modest.

"At a time when people really want" junk bonds, "supply and demand are still pretty much in balance," Patel said, adding that there hasn't been "a big increase in the amount of high yield bonds to sop up all that demand."

Looking out over the remainder of the year, Schroeper said that because the junk bond market is now "pretty fairly valued," or possibly "slightly overvalued," there is a possibility it will pull back. A heavy increase in issuance will probably pull bonds lower, but if supplies hold steady, bond funds can probably generate total returns of about 7%-8% for the year, he said. Many other junk bond fund managers have also said they expect returns in that range.

"The real wild card" in determining returns for the sector "is what happens with interest rates," said Gibson Smith, who oversees the Janus High Yield Fund (JAHYX).

"We've really got a market that has been moved by interest rates," Smith said.

High-Yield Bond Funds

Best Performers

Third Quarter 2004 Returns Through 9/30/04 (%)

Worst Performers

Third Quarter 2004 Returns Through 9/30/04 (%)

Loomis Sayles Institutional High Income (LSHIX)

+6.8

Eaton Vance Floating-Rate/C (ECBLX)

+0.3

Manufacturers Investment Trust: High Yield/III

+5.8

Mainstay Floating Rate/C

+0.4

Delaware Group:Delchester Fund/B (DHYBX)

+5.7

ING Senior Income Fund/C (XSICX)

+0.4

AXP High Yield Bond Fund/Y

+5.4

Fidelity Advisor High Income Advantage/C (FAHEX)

+0.5

Franklin AGE High Income Fund/Adv (FAHAX)

+5.4

Franklin Inv Sec:Floating Rate Dly Access/B (FBFRX)

+0.5

High-Yield Bond Funds

Best Performers

2004 Returns Through 9/30/04 (%)

Worst Performers

2004 Returns Through 9/30/04 (%)

Regions Morgan Keegan Sel High Income/I (RHIIX)

+10.5

J Hancock High Income Fund/C (JCHIX)

+0.3

Delaware Pooled Tr:High Yield Bond (DPHYX)

+10.4

Manufacturers Investment Trust: High Yield/III

+0.8

Credit Suisse Instl High Yield (RBSFX)

+9.7

Eaton Vance Floating-Rate/C (ECBLX)

+1.6

Eaton Vance Floating-Rate High-Income/C (ECFHX)

+8.8

Eaton Vance Floating-Rate High-Income/C (ECFHX)

+2.0

Delaware Group:High Yield Opportunities/I (DHOIX)

+8.6

Fidelity Advisor Floating Rate High Inc/C (FFRCX)

+2.0

Source: Standard & Poor's. Data as of 9/30/04.

Contact Bob Keane with questions or comments at: bkeane@investmentadvisor.com.

Reprints Discuss this story
This is where the comments go.