Junk Bond Substitutes That Offer Good Yields
If this week’s selloff of high-yield junk bonds has you scared of junk bond mutual funds, you’re not alone. Investor withdrawals, which picked up in July and August, have accelerated in recent days amid sharp price declines in issues of Campeau Corp. and other troubled firms and urgings by some investment experts to avoid these funds.
Fund groups such as Fidelity, T. Rowe Price and others are reporting a surge in outflows this week, with much of the cash going into money market funds.
Are there other alternatives? Unfortunately, there are not many other types of mutual funds that offer the 10% to 15% yields of many junk bond funds. There are, however, several other types of funds that provide reasonably decent yields or the potential for capital gains along with yields.
And don’t write off all junk bond funds because they are not all the same. Some invest in higher-quality issues that are not considered as risky as others.
Here’s a look at junk bond funds and some alternatives:
- Junk bond funds. Some funds have been reducing their risk in recent months by sticking to the safest and most salable issues. They also have been raising cash levels to meet possible investor withdrawals without resorting to panic selling. Others, however, continue to favor riskier issues to prop up their yields.
Lori Lucas, an analyst at Mutual Fund Values, a Chicago publisher of fund information, lists several conservative junk funds. They include Eaton Vance Corporate High Income, Kemper High Yield, T. Rowe Price High Yield, Putnam High Yield and Cigna High Yield. On the other hand, funds that have sought high yields at the expense of safety include Alliance High-Yield, Venture Income Plus, American Capital High-Yield, Keystone Custodian B-4 Series and Bull & Bear High Yield, she said.
But the risk exists that a massive panic such as this week’s could lead to a selloff of even the safest issues, hurting conservative funds, analysts caution.
“This is not a liquid market,” says William E. Donoghue, publisher of Donoghue’s Moneyletter, a Holliston, Mass., newsletter. In a panic, “there may not be a buyer at a fair price out there. The last person out will get a whole lot less than the first person out.”
- High-grade corporate bond funds. These invest in blue chip corporate bonds, far safer than junk bonds. But they don’t yield as much either, now paying about 1 percentage point above Treasury issues of comparable maturities, compared to premiums of close to 6 percentage points for junk bond funds.
And high-grade corporates are not entirely risk free. They can lose value through so-called event risk, when the issuing corporation takes on greater debt through a takeover, leveraged buyout, restructuring or other transaction.
Joe Mansueto, president of Morningstar Inc., a Chicago-based advisory service that publishes Mutual Fund Values, suggests Boston Co. Managed Income and Strong Income as high-grade corporate bond funds with strong track records.
- Government bond funds. These usually invest in safe Treasury securities, so the bonds are free from default risk. But funds investing in long-term bonds of say, 10 years or longer in maturity, are not free from fluctuations in value. That is because when interest rates rise, as they have in the past two months, prices of long-term bonds fall.
Another drawback on long-term bonds: Their yields now are not that much greater than on shorter-term bonds. Thirty-year Treasury bonds, for example, are yielding about 8.10%, compared to about 8% for six-month or one-year Treasury bills. So unless you are convinced interest rates are heading downward in the coming months, most experts advise sticking to short- or intermediate-term government bond funds for now. But if you think interest rates are heading south, long-term bond funds can be very profitable because their prices rise when rates fall.
- Ginnie Mae funds. These funds, which invest in securities of the Government National Mortgage Assn. that are backed by mortgages of ordinary homeowners, are a good choice for conservative investors, many advisers say. Their yields are about 0.5 to 1 percentage point higher than Treasuries, and they are less volatile, not rising as much as Treasuries when interest rates fall but not falling as much when interest rates rise.
“In a flat or down market, you’ll be fine,” Mansueto says of Ginnie Maes. “These are good for those who don’t know where (interest rates) are going as a way to hedge their bets.”
Among Ginnie Mae funds, Mansueto suggests Benham GNMA Income, Vanguard GNMA Portfolio, Fidelity Mortgage Securities Portfolio and Fidelity Ginnie Mae Portfolio.
- High-yielding stock funds. Some analysts argue that junk bond funds are really more like stock funds than bond funds because prices of junk bonds--like stocks--rise or fall according to the financial fortunes of their corporate issuers. Therefore, you might consider mutual funds investing in utility stocks or other issues that stress high income along with modest potential for price appreciation.
Fund analyst Mansueto suggests Dodge & Cox Balanced Fund, Fidelity Puritan, Founders Equity Income, Lindner Dividend, Mutual Qualified, T. Rowe Price Equity Income or Wellington Fund.
Among utility funds, he suggests Fidelity Select-Telecommunications, Prudential-Bache Utility Fund or Fidelity Select-Utilities.
- Money market funds. If this week’s junk bond rout has you scared of anything even remotely risky, stick to money market funds. At Fidelity Investments, the nation’s largest mutual fund group, most investors moving out of its junk bond fund in the past two days have gone into money funds, reports Neal Litvack, vice president of marketing. These funds are virtually as safe as bank certificates of deposit or Treasury bills because they invest in them.
Several money funds, including Dreyfus Worldwide Dollar, Fidelity Spartan and Vanguard Money Market Reserves-Prime, are paying annualized compounded yields at or above 9%.
Bill Sing welcomes readers’ comments and suggestions for columns but regrets that he cannot respond individually to letters. Write to Bill Sing, Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.
