High-yield Bonds Look Good Later in the Year
- Alan Lavine and Gail Liberman
The name of the game is risk and reward. Sometimes you take the risk and you profit. Other times you can lose your shirt.
Take the case of the high-yield bond market. Low-risk U.S. Treasury bonds yield around 4 percent. By contrast, high-yield bonds issued by companies with poor credit ratings yield over 9 percent. So you could earn 5 percent more in income during the year with a high-yield bond.
Of course if the economy doesn't perform well, companies with poor credit ratings will have a tough time paying the principal and interest on the bonds. So high-yield or junk bond prices drop. There also is a much greater chance that a company offering a high-yield bond could default leaving you out in the cold.
High-yield bond prices tend to do well when the economy is growing and stock prices are rising.
Over the past 10 years, the average high-yield bond fund has grown at a about a 7 percent annual rate. But if you had reinvested high-yielding income into the fund over the last five years, the investment would have grown at just a 1.64 percent annual rate. If you had taken the income from the fund in cash, you would have lost money.
Can't afford to risk losing your principal? Then stay far away from high-yield bond funds. But if you make a high-yield bond fund a small part of your holdings, you may be able to benefit.
James Caywood, manager of the Enterprise High-Yield Bond Fund, isn't optimistic about the outlook for high-yield bonds over the near term. He believes the economy may slip back into a recession. Later this year, it should recover.
Caywood says the uncertainty of war is leading to slower consumer spending and continued pressure on profits and corporate financial strength.
The fund yields 7.9 percent and is rated four stars by Morningstar Inc., Chicago. The fund's largest industry concentrations are in hotels and restaurants, retail, food and telecommunication sectors. Largest holdings include Pioneer Natural Resources, Grupo Televisa, Sealy Mattress, Briggs & Stratton and Gap.
Margaret Patel, manager of the Pioneer High-Yield Fund, says that high-yield bonds could register a total return over 9 percent this year. But a lot depends on how the economy performs. If the economy grows and consumer spending picks up steam, high-yield bonds should perform well.
The fund yields 9.3 percent. It is rated five stars by Morningstar. Patel invests in companies that are leaders in stable expanding industries. The companies must have unique products. They also must have stronger balance sheets and cash flow than their peers. The companies show moderately increasing revenues and cash on the books. The largest holdings include Ivax Corp., Crescent Real Estate and J.C. Penny. Largest industries include capital goods, industrial products and services.
Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).
To read more columns, please visit the column archive.