High-yield bonds could be a good investment in 2008, as investors shake off their aversion to risk.
Junk just ain’t what it used to be.
Year-to-date through November 15, high-yield bonds put up a total return of only 3%, at a time when Treasuries had a total return of 7.7%. The relative outperformance of Treasuries can be attributed to the “flight to safety” undertaken by many investors in 2007.
But in 2008, many market prognosticators are expecting a much better year for high-yield bonds.
An intriguing analysis by T. Rowe Price and JPMorgan shows that so-called “problem” industries (housing, financial services, retailers, and consumer products) represent only 13% of the high-yield asset class. The sectors that represent the most (energy, utilities, and health care) “should be resilient even if the economy slows,” says Mark Vaselkiv, manager of the T. Rowe Price High Yield fund.
At Pioneer High Yield fund, portfolio managers Andrew Feltus and Tracy Wright have been taking advantage by purchasing higher-quality names for the portfolio. “In third quarter trading, we initiated a number of positions in response to more attractive valuations, and reduced our exposure to the paper and REIT sectors in favor of energy firms. We invested in the bonds of chemical firm Ineos, which had widened despite strong earnings over the past two quarters, as well as in the bonds of Parallel Petroleum; higher-quality insurance firm Leucadia; and Complete Production, an oil services firm.”
Diane Vazza, a managing director for S&P Ratings Services, predicts a speculative-grade default rate of 3.4% in the United States by the end of October, 2008. That, she says, is “much higher than current levels but still lower than the 4.5% historical average.”
Putting that default rate prediction into context, it means 56 issuers must default. By contrast, only 14 U.S.-based issuers have defaulted so far this year.