Take a Look at Junk - Barron's

September, perhaps not surprisingly, was the worst month ever for high-yield corporate debt - also known as junk bonds. Junk's 8% one-month drop was, statisticians say, an anomaly so rare it should happen only once every 28,000 years, or so. With average junk yields now about 15% - more than double that of a year ago - and the Treasury/junk spread at a staggering 12%, Barron's says junk may be a bargain.

"The market has fallen so sharply that it's difficult to declare a bottom," investment advisor Marty Fridson says. "It's hazardous to jump in, but historically you would have made money buying in times like these if you were patient."

Previous selloffs in 2002 and 1990 were followed by surges of 28% and 39% the next year, Barron's notes. Default rates are a modest 3.2% - but markets are pricing in an increase to 10%+ over the coming year. Veteran bond manager Dan Fuss notes that even if defaults hit Depression-era levels, bonds should still beat Treasurys over the coming years. If the markets bottom and the credit crunch abets, investors could earn 25% in the next year.

Large ETF and closed-end junk bond funds include SPDR Lehman High-Yield Bond index (JNK), Western Asset High Income II (HIX), BlackRock Limited Duration Income (BLW) and Dreyfus High-Yield Strategies (DHF).

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Surprisingly, the two areas of bond investing that have seen large inflows this year are international bonds and junk.

Comments

[whidbey:]

Why would this surprise anyone? It is likely an early entry, but the play is reasonable in theory anyway. Only timing is an issue, and maybe the class of junk. I am holding some very choice junk from some our best corporations with weak balance sheets. But I have 45% losses at this point. I obviously want to believe and history is on my side, but who trusts this economy and this government? Sleepless in Seattle.

2008 Oct 05 09:07 PM

[Ames Tiedeman:]

Way too early on these names.

2008 Oct 05 09:15 PM

[Larry House:]

I have owned HIX but don't now. I agree with the comment that it is just too soon because junk bonds will mirror the economy and act much as stocks will. I prefer to take a chance on Bill Gross and have put money in PTTDX, which is over 80% in cash, and HABDX, which is almost 60% in cash. I trust (and hope) if anyone can find value in fixed income right now he can. I prefer, rightly or wrongly, to have money in a managed fund right now that has the cash to buy discounted securities as they become available. With such a flight to safety, junk bonds are the last place I want to be. Months ago I bought some A-rated bonds, investment grade, short maturities. I bought them for safety and secure income with stocks looking so bad. Guess what? They became junk bonds (Lehman Brothers), and none of the rating agencies gave any warning that they were so risky. What really concerns me are the many, many companies with BBB and A-rated bonds that may become junk in the next couple of years. Buy quality, accept the lower yield and protect your capital.

2008 Oct 05 11:53 PM

[User 265729:]

As Ames said, way too early. Way too early for bottom.

Asia doesn't look good and the markets are awash in red from one end of the globe to the other. I don't know how Europe will do, but so far $700 billion bought more red charts -- thank you Congress for your unending insight into the economic crisis -- but I digress.

2008 Oct 06 12:21 AM

[couldashoulda:]

ETF AGG has cheaper fees by 1/2, better perfromance in past year by factor of 2 and is more flexible. Why use these mutual funds ??

2008 Oct 06 07:50 PM

[couldashoulda:]

whoops ! my above post was intended for a different article. SORRY

2008 Oct 06 07:52 PM

[Hiyield007:]

As several have mentioned above way, way too early. And in the three market days since the Barron's article, the average open end junk bond fund (which best reflects the cash market) is down between 4% to 5% while the closed end junk funds have taken a much more severe pounding. This is now the worst junk bond bear market of all time. I never thought I would see anything as bad as the 89-90 affair but this one takes the cake. Junk bonds are the most trend persistent asset class out there and this bear trend will not be easily broken. My concern is that the default rate will hit historical highs in 2009 and normally new junk bull markets don't develop until we are right at or near the peak of defaults.

2008 Oct 08 11:06 PM

[CloroxCowboy:]

I am considering lightly purchasing a few of these...for someone like myself with a very (very) long term view they should work out well. As I'm not expecting full-blown depression (or the associated default levels) these yields are attractive enough that I don't care about calling the bottom precisely. With a play that I believe will be viewed as a steal several years from now, it's better to load up slowly on the way down than worry about timing and possibly miss a decent entry.

2008 Oct 10 12:21 PM

[Hiyield007:]

Clorox Cowboy not all that bad of an ideal, just don't go overboard. Junk bonds are the most trend persistent asset out there and once they begin trending it is hard to break the momentum be it up or down. I prefer to wait for more signs of life and some indication the down trend is over. My concern is that default rates on junk bonds may be much greater than many expect in 2009 and hence we have a ways to go on the downside. On the other hand, junk often bottoms with the stock (October 2002 is a good example) so I may jump back in if I see some indication the stock market bear has ended. I will admit though, this fund has never has this type of carnage since its inception back in the 80s and it's tempting to leg in as you suggest. Personally though my open end junk bond of choice isn't going to be Vanguard. It always lags in bull markets. It normally outperfomrs its peers in bear markets but sure isn't this time around.

2008 Oct 11 01:06 AM

[CloroxCowboy:]

Hiyield007, thanks for the response. I agree with your idea that these are slow to rebound, and for someone with better timing skills I say wait it out. I'm sure they will get a bit cheaper, however I don't have the best record when it comes to calling bottoms and usually tend to do better scaling in slowly. I should have made it clear that this is a personal tactic for me. I do think that flatter times are ahead, and the spread over Treasury is still attractive enough to make me risk being wrong about that. I'm comfortable holding my position for as long as I'm collecting a decent yield (or a great one if defaults don't get crazy), until I can sell for a price appreciation.

If not Vanguard, what is your OE fund of choice? I definitely plan to diversify on this move.

2008 Oct 13 09:11 AM