Turmoil Puts Junk Funds in a Kind of Trading Limbo
For junk bond mutual funds--the custodians of small investors’ $28-billion junk stake--there’s little to do but sit and watch the current turmoil.
In a market once again turned upside down by fear of the future, many fund managers say they’re unable to sell bonds, or even buy, in most cases. So the funds are locked in a sort of suspended animation.
The question is whether fund investors are willing to sit through this, and for how long, even when offered annual interest of 15% or better. For now, most junk funds say investors aren’t clamoring to redeem their shares. But if investors begin to bail out as they did last autumn, the funds could find themselves forced to liquidate bonds, further bashing an already weak market.
Tuesday, many junk funds took the view that the investors who didn’t belong in junk were mostly shaken out of the funds last year. “The people (remaining) have basically decided they’re going to stay in,” said Neal Litvack, vice president of marketing for Fidelity Investments’ income funds.
He said redemptions Tuesday, in the face of Drexel Burnham’s collapse, totaled $10 million from Fidelity’s $1.2-billion-asset High Income Fund. Litvack called that a “relatively mild” reaction compared to investors’ redemptions last autumn.
At T. Rowe Price Associates in Baltimore, spokesman Steven Norwitz said the company’s $700-million-asset High Yield Fund, which has 69,000 shareholder accounts, had gotten “a few calls from people worried about the market.” But redemptions were light, he said.
Many junk bond fund managers took precautions last autumn, when the market was first slammed by the troubles of such junk borrowers as Campeau Corp. and Resorts International. Some funds have built up higher-than-normal cash hoards, so they can meet shareholder redemptions without being forced to sell bonds into a depressed market.
Tom Nugent, manager of the Los Angeles-based Pacific Horizon High Yield Fund, said 14% of the fund’s $14 million in assets is in short-term “cash” securities that can be easily sold. The average junk bond fund held 6.9% cash in December, according to the Investment Company Institute, a fund trade group.
Yet managers at many funds don’t seem worried about redemptions, even though the funds as a group have continued to see a net outflow of money since September. What exasperates the managers is their inability to do much of anything right now.
Despite the junk market’s $200-billion size, it had always been a largely illiquid market. Now, the middlemen--the brokerages that should be working to bring buyers and sellers together--are unwilling even to perform that basic task. Drexel’s fall makes that situation chronic. Result: paralysis, except for a few of the biggest junk bond issues.
The market’s lockup “is probably unprecedented in size and scope” within the fund industry, said Michael Lipper at Lipper Analytical Services, a fund tracker.
That paralysis makes it futile to contemplate major portfolio moves, fund managers say, explaining their lack of panic. “I’m not sure what good panic would do,” said Nugent, who owns bonds of such companies as Carolco Pictures, RJR Nabisco and AMC Entertainment. “Your ability to sell bonds in any size is severely limited.”
Meanwhile, many managers contend that if they can buy, they are doing so. Bonds of many junk issuers have fallen so low in price--70 to 90 cents on the dollar--that it suggests all such companies are in danger of defaulting on their debt. In fact, most of the companies have no problem making their interest payments, fund managers say.
“I’ve met the managements of every company in this portfolio,” said Curt Barrows, who runs the $116-million-asset Phoenix High Yield Fund in Hartford, Conn. Citing the bonds of such firms as Texas Eastern, Kroger Co., Occidental Petroleum and Safeway Stores, Barrows insists “these are all good companies.”
Ken Urbazewski, manager of the $1.3-billion-asset Kemper High Yield Fund in Chicago, said he has been buying bonds from Drexel itself over the past few days. Even if junk prices just stabilize over the next few months, rather than rebound, the 14% to 20% annualized yields on many of the bonds make them very lucrative for anyone with a long-term view, he argues.
The problem for mutual fund shareholders is that they’ve been hearing that kind of talk for the past six months--as the junk market has continued to sink.
The average junk fund lost 2.74% of its value in January, Lipper reports. Over the past 12 months, despite sky-high interest yields, the funds’ average total return was a negative 5.29%. What that means: Even though many funds earned interest of 12% or better in that period, the decline in the bonds’ prices was so severe that it effectively wiped out the interest and more.
In addition, investors with a long-term view are sobered by another figure: The average junk fund had a total return of just 42% in the five years ended Jan. 31--no better than the average return of money market funds in the same period. That may cause many investors to reassess the merits of staying in junk long term.
Perhaps the biggest worry now for fund shareholders is that there simply aren’t enough other investors who will take a long view.
Prodded by regulators, insurance firms and savings and loans are likely to continue to sell off their junk holdings this year. The potential sale of Drexel’s portfolio of bonds will add to the supply. Mutual fund buying alone is unlikely to be enough to spur a sharp recovery in junk prices.
So where will the demand come from to rescue the market? Many fund managers believe that junk companies themselves will buy back their bonds.
Some companies with depressed junk bonds outstanding have already begun quietly buying a portion of the bonds, fund managers say. The advantage is that the companies can retire debt at a fraction of the cost, while sharply reducing their interest costs. “I think you’ll see a lot more of that,” said Nugent.
Lipper, meanwhile, suggests that big-money private investors will see great opportunities ahead to pick up bonds of good companies--for 15%-plus current yields, and for huge capital gains when bonds bought at, say, 70 cents on the dollar are eventually paid in full when they mature.
Though no one is willing to predict that the junk market has yet bottomed, at some point the smart money will rush in, fund managers say. On Wall Street, says Lipper, “There are plenty of people whose nom de plume is vulture.”
THE DECLINE OF JUNK BOND MUTUAL FUNDS
As investors have redeemed their shares, assets in the funds have dropped sharply.
NET SALES *
* Net sales of mutual fund shares minus redemptions
TOTAL NET ASSETS
Source: Investment Company Institute
