High-Yield Bond Funds -- Second Quarter 2002 Revie

July 2, 2002 — Money managers who oversee investments in high-yield or “junk” bonds have been expecting a turnaround in the sector since the start of the year. They’re still looking for it.

Overall high default rates, and weakness in telecommunications companies continued to plague below-investment-grade bonds in the second quarter, as they have since last year.

Adding to those problems, say fund managers, are concerns about the credibility of corporate bookkeeping and management, which have made investors reluctant to invest in high-yield bonds — or anything else.

High-yield bond funds took another hit on June 25, when WorldCom Inc., whose debt had been downgraded to junk in recent months, disclosed accounting irregularities, helping to drive some funds down 2% to 5% the next day. When the quarter finally ended, the average junk bond fund had lost 5.08%.

“All the hopes that people had at the beginning of the year haven’t come to fulfillment,” said Margaret Patel, who runs the Pioneer High Yield Fund/A (TAHYX).

Patel said high-yield bonds were also hurt over the last three months by the tepid economic recovery, which kept many issuers from improving their operating performance.

Poor corporate results, Patel said, contributed to defaults, which have been hovering around 10%.

Brandan White, manager of the Touchstone High Yield Bond Fund/A (THYAX), believes that default rates “are not going to decline rapidly any time soon,” although they “should ease down” to about 8%-9% by the end of the year.

Ernest Monrad, who helps oversee the Northeast Investors Trust (NTHEX) said that if the troubled telecommunications industry’s bonds are excluded, overall default rates for junk bonds have only been about 4%-5%.

The Northeast fund was the top performer among junk bond funds in the quarter, returning 7%. Monrad said the portfolio was helped because it had no exposure to telecommunications or technology companies, while maintaining stakes in energy, chemicals and gaming companies, which should prosper as the economy strengthens.

The fund had 11.9% of its assets in energy companies at the end of May, Monrad said. Gaming companies accounted for about 10% of its holdings, and chemical companies 5.6%, he said.

Monrad said he likes these kinds of companies because they have tangible assets. “There is something there that you can get your hands on, not just customer lists or wire that nobody wants,” he said.