News and analysis from Standard & Poor’s MarketScope Advisor
With the ups and downs of the stock market over the past two years enough to give even seasoned investors indigestion, the lure of a monthly interest check is almost irresistible. Record low interest rates, however, mean that check isn’t very much for owners of investment grade bond funds, so more and more people are turning to high-yield “junk” bond funds in search of decent returns.
High-yield bonds–those with a credit rating of BB+ or lower–have rallied substantially in early 2010 amid the combined effects of investors searching for yield and expectations that U.S. economic growth will accelerate in the future. Standard & Poor’s economists are looking for U.S. gross domestic product growth of 3.0% in 2010, and 2.9% in 2011, which would improve the profitability of less credit-worthy borrowers and make it easier for them to repay loans.
There are roughly 100 high-yield bond funds available to U.S. investors, both load and no load, with annual expense ratios that range from 0.15% to more than 2.7%. In addition to U.S. high-yield corporate bonds, several funds also own equities and foreign bonds in their portfolio. These funds have delivered average annual returns over the past five years varying from 11% to negative 22%.
Among these funds, we screened for those that had Standard & Poor’s 5 star rank, $20 million or more in assets, no upfront sales load, and minimum initial investments of $20,000 or less. We then sorted through the dozen funds that meet those criteria, looking for funds that combined low expense ratios, consistently strong performance over the past one-, three-, and five-year time periods, and high distribution payments, and chose three funds with different combinations of attractive features.
For consistently strong performance combined with low cost, it’s hard to beat the $11.7 billion Fidelity Capital and Income Fund (FAGIX *****). Over the past five years, the fund has delivered an average annual return of 8.86%, the sixth best of the entire high-yield group, while charging an annual expense ratio of 0.78%, among the lowest of the group. Its three-year average annual return of 7.41% is within the top 10 of high-yield funds, as is its one-year return of 73.8%. The fund currently has an SEC 30-day yield of 6.36%, similar to the other funds chosen. It is the most highly diversified, with 535 holdings, and has about 15% of assets invested in equities and 13% in foreign debt.
An even stronger performer, however, is the Aegis High Yield fund (AHYFX *****), which has delivered an average annual return of 9.68% over the past five years, fourth best among all high-yield bond funds, and its 7.6% return over the past three years beats Fidelity Capital and Income’s. It nearly matched Fidelity’s fund in one-year performance with 71.8%, and its 30 day yield of 6.35% is about equivalent as well. The fund’s costs, at 1.2%, are significantly higher than the Fidelity fund, though slightly below the peer average of 1.27%, according to Lipper data. With assets of $22 million spread across just 49 holdings, it has a far more concentrated portfolio than the other funds.
The Artio Global High Income Fund (BJBHX *****) has delivered similar returns to investors as the Fidelity and Aegis funds, with a five-year average annual return of 8.53% and a three-year average annual return of 7.51%, and while its 53% gain over the past year trails the other funds appreciably, it is still above the peer average of 47.4%, according to Lipper data. This $1 billion fund has 22% of its holdings in non-U.S. companies. Its expense ratio of 1.02% is below the peer average. More than 20% of its 146 holdings are from non-U.S. issuers.
S&P Senior Financial Writer Vaughan Scully can be reached at [email protected]. Send him your ideas for mutual fund story topics.