High-Yield Bond Funds -- Third Quarter 2004 Review

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.