High-Yield Bond Funds -- Mid-Year 2005 Review

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The high yield bond market bounced up and down during the second three months of the year before ending the quarter modestly higher.

The average mutual fund that invests in high-yield, or junk bonds, returned 1.5% during the period. For the first half of the year, the funds rose 0.8%.

"The market has been schizophrenic this year," said Mark Vaselkiv, who runs the T. Rowe Price High-Yield Fund (PRHYX).

Junk bonds were overvalued through mid-March, which led to a downturn late in the month that lasted until the middle of May, Vaselkiv said. Since then, the sector has rallied somewhat, he and other observers said.

Standard & Poor's has found that volatility in the U.S. speculative-grade market intensified in April and May, but appears to be retreating in June.

Observers said that starting at the end of the first quarter, investors were worried that the market would be hurt by higher interest rates as the Federal Reserve tightened monetary policy.

There were also concerns about the market's ability to digest large batches of bonds from giant automakers General Motors (GM) and Ford Motor (F) that were downgraded to junk status in May.

Neither problem materialized, however. Although short-term interest rates have ticked up, long-term rates, which junk bonds tend to follow, have moved lower or stabilized. And the entrance of GM and Ford went smoothly.

"We weathered the GM-Ford storm, and the rate storm turned out to be a shower instead of a thunderstorm," said Dana Erikson, who oversees the Evergreen High-Yield Bond Fund (EKHAX).

But junk bond gains over the rest of the year stand to remain limited because investors are still somewhat jittery about the car manufacturers' downgrades and long-term interest rates, he said.

Fears that domestic economic growth will slow significantly are also weighing on the junk bond market, said Peter Ehret, one of the managers of the AIM High-Yield Fund/A (AMHYX). A weaker economy could hinder companies' ability to reduce debt.

Still, the junk bond market continues to be underpinned by conditions that have helped it over the last two years, observers said. The economy is still growing, and corporate earnings and balance sheets have improved.

Also, the default rate for U.S. junk bonds remains very low, hovering around 2%. U.S. speculative-grade default rates are at a trough and poised to rise at the tail end of 2005, but the forecast is still very modest from a historical perspective, Standard & Poor's finds.

"The fundamental backdrop for the (high yield) market is pretty good," Erikson said.

Looking out over the remainder of the year, money managers said they expect to see junk bond funds generate total returns of about 3%-5%.

"You sort of clip your coupon, plus or minus a little bit," said Carolyn Gibbs, who helps run the AIM High-Yield Fund.

High-Yield Bond Funds

Best Performers

Second Quarter 2005 Returns (%)

Worst Performers

Second Quarter 2005 Returns (%)

Summit High Yield Bond Fund (SAPHX)

+4.2

Merit High Yield/C (MEHCX)

-6.8

Loomis Sayles Institutional High Income (LSHIX)

+3.8

First Investors Fund for Income/B (FIFJX)

-0.8

TA IDEX Transamerica Consrv Hi Yld Bd/A (IHIYX)

+3.7

Merrill Lynch US High Yield Fund/C (MCCHX)

-0.6

John Hancock Trust High Yield III

+3.2

Excelsior High Yield Fund/Institutional (EXHYX)

-0.4

Integrity High Income Fund/A (IHFAX)

+3.1

First Investors Fund for Income/A (FIFIX)

-0.4

High-Yield Bond Funds

Best Performers Mid-Year 2005 Returns (%) Worst Performers Mid-Year 2005 Returns (%)
Regions Morgan Keegan Sel High Income/I (RHIIX)

+2.2

Potomac Dynamic High Yield Bond/Investor (PDHYX)

-8.0

AIM Floating Rate Fund/B (XAFRX) +1.5 Buffalo High Yield Fund (BUFHX) -3.3
ING Senior Income Fund/Q (XSIQX) +1.4 AFBA Five Star High Yield/C (AFHCX) -3.0
Oppenheimer Senior Floating Rate/A (XOSAX) +1.3 Merrill Lynch Bd:High Income Fund/C (MCHIX) -2.9
Security:Income Opportunity/A (SIOAX) +1.3 Potomac Spectrum High Yield Plus Fund (SFHYX) -2.9

SOURCE: Standard & Poor's. Total returns are in U.S. dollars and include reinvested dividends. Preliminary data as of 6/30/05.

Contact Bob Keane with questions or comments at: .

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