Surprising News About Junk Bonds
Investors who’ve held on to their junk bond mutual funds this year, despite the bonds’ winter crash, can proudly say that they didn’t sell at the lows: Junk bond values have climbed back surprisingly over the past month.
The average junk bond fund had a total return of 2.10% in May, according to Lipper Analytical Services. Total return measures interest earned, plus any appreciation in the bonds’ prices.
The May gain helped erase much of the damage from the winter plunge, after junk bond king Drexel Burnham Lambert collapsed. Year-to-date through May 31, the average junk fund now is off 2.01%, measuring total return.
That may not feel very good when the average stock mutual fund is up 3.3%, and the average Treasury bond fund is up 0.13%. Still, things looked a lot worse in early March, when many junk funds were down 7% or more from Jan. 1. And if bond prices just stay level, interest earnings could soon put junk funds back in the positive column.
What happened in May was that more bargain hunters got serious about buying junk. Convinced that the economy wasn’t going to collapse, and lured by junk bond annualized yields exceeding 15%, buyers chased junk as market interest rates fell. It also helped that many of the companies that had borrowed via junk bonds in recent years decided to buy some of them back, given the depressed prices.
Despite the strength of the May rally, however, many junk experts are wary about calling this a sustainable surge. The reason: Buyers fishing for depressed bonds have mostly concentrated on the biggest, safest junk issuers only. Trading in most corporate junk bonds remains treacherous at best.
“There are 50 or 60 names that everybody’s jumped on,” said James Caywood, head of San Diego-based Caywood Christian Capital, which owns about $1.2 billion in junk. “But there are another 600 names that nobody has a clue about.”
Tom Nugent, who runs the $12-million (assets) Pacific Horizon High Yield fund in Los Angeles, has been a victim of that two-tiered market. His fund, heavily invested in higher-yielding, lower-quality issues, eked out only a small gain in May. It was hurt in part by a plunge in the value of bonds issued by Divi Hotels Corp., which operates Caribbean hotels. When Divi said it was unable to make its interest payments, the bonds tumbled to about $250 apiece from about $550.
Besides worrying about a continuing dearth of buyers for most bonds, junk fund managers warn that if fears again mount that the economy is crumbling, many junk owners are likely to bail out. Most investors won’t want to stick around and see how many more financially weak junk debtors will end up in bankruptcy court.
“The market remains very vulnerable to a full-scale recession,” said Bill Veronda, manager of the $46-million asset Financial Group High Yield fund in Denver.
Even so, Veronda and his peers admit that they were surprised by the sum of money that flowed back into junk in May. “We literally saw some of the same people coming back who had sold out in a panic” last winter, Veronda said. His fund saw a small net inflow of money from investors in May, after a long string of monthly losses.
He also is encouraged by investors’ reaction to the troubles of issuers such as Donald J. Trump and Macy’s. Though those bonds have plunged recently, “Their troubles haven’t carried over to the general market,” Veronda said.
How Wells Fargo Picks Stocks: Among L.A.’s money pros, one of the quiet giants is Wells Fargo Asset Management, which actively manages about $30 billion in investor funds.
San Francisco-based Wells Fargo probably is best known for its “passive” stock management division, which essentially attempts to replicate market performance by exclusively owning the stocks in major market indexes, such as the Standard & Poor’s 500 index.
While that Wells division now runs about $70 billion for investors, the active management arm has been gaining notoriety for its stock-picking prowess. Over the past five years, Wells’ model growth stock fund has beaten the average stock mutual fund by about 2 percentage points a year.
Wells veteran Robert Bissell was named to oversee all of the firm’s portfolio operations in 1989. Bissell, based in L.A., describes Wells’ active management strategy as aggressive on individual stocks but growing cautious overall on the market.
“Our thinking is, you may not want to throw a lot of money in at the 2,900 level (on the Dow Jones average),” Bissell said. “The market could go forward . . . but you’re into territory where it becomes a lot more volatile,” he said.
As for individual stocks, Bissell said Wells’ style is “different than just trying to pick this quarter’s winner.” In searching for stocks that have the potential for big gains, Wells’ goal is to be into the story early, he said. The firm’s 30 portfolio managers are rewarded for spotting ideas before the rest of Wall Street spots them.
Indeed, Wells emphasizes that its portfolio managers have to be good at doing their own homework on stocks. The firm employed analysts to assist the portfolio managers until 1986, then jettisoned the analysts. Bissell said his experience is that analysts tend to “filter out information, rather than develop new ideas.”
Operating independently, Wells’ portfolio managers can tap ideas from a wide range of sources, including analysts employed by Wall Street brokerages. Wells has a reputation for demanding a lot of those analysts. “We manage Wall Street a lot harder,” Bissell admitted. “We make them jump through little hoops” for Wells’ business, he said. The reason simply is that “really good stock ideas are hard to come by,” he said.
Along the same lines, Wells doesn’t spread its dollars over a wide universe of stocks, despite running $30 billion. “We tend to focus in on about 300 companies,” Bissell said. “If we’re going to take a position in a stock, we’ll make it meaningful.”
The firm’s best ideas show up on a 20-stock focus list. Some of the stocks on that list now include Bank of New York ($37.625 Thursday), North Carolina banking giant NCNB ($41), heavy equipment makers Harnischfeger ($20.25) and Caterpillar ($67.125), computer maker Tandem ($25) and insurance firm Aon Corp. ($40.625).
Technology stocks are “notably absent” from the stock list now, Bissell said, because Wells’ portfolio managers no longer see much value in the group, which has soared this year.
Briefly: The Greenwich Associates poll of 1,500 money managers once again named Goldman, Sachs the best brokerage for stock research, Investment Dealers’ Digest reports. The Greenwich poll isn’t released publicly but usually is leaked. Merrill Lynch came in second, and First Boston was third. . . . Allergan, the Irvine-based eye-care products firm, has picked up another recommendation. Bateman Eichler, Hill Richards recently initiated coverage with a “buy” recommendation. Allergan closed at $18 Thursday.
THE RETURN OF JUNK
Junk bond mutual funds rallied sharply in May, as bargain-hunters chased after selected depressed bonds, bidding the prices up significantly. But most funds still are down for the year. A cross section:
Total investment return: 12 mo. Bond fund May Year-to-date yield American High-Income 3.35% 2.19% 12.3% Franklin AGE High Income 2.93% -2.34% 16.8% SunAmerica Income Plus .45% -2.84% 14.8% Mid-America High-Yield 2.44% 1.04% 10.8% Vanguard High Yield 2.35% 0.22% 13.5% SunAmerica High Yield 2.33% -1.47% 15.0% Fidelity High Income 2.12% -1.81% 14.2% Financial Group High Yield 2.07% -1.11% 13.6% Pru-Bache High Yield 1.93% -3.06% 13.8% Pacific Horizon High Yield 0.24% -8.02% 17.3% Average junk fund 2.10% -2.01% 14.5% Avg. Treasury bond fund 3.03% 0.13% 8.5%
Year-to-date data through May 31. Source: Lipper Analytical Services Inc.
