Investors Eyeing Junk Securities

From Bloomberg News and Times Staff

With the economy apparently reviving, some investors are betting that the corporate junk bond sector will be a big beneficiary.

Junk bond mutual funds attracted $1.23 billion in net new cash in the week ended Wednesday, the most in five years, according to a Merrill Lynch & Co. report of AMG Data Services figures.

The surge of new money into junk funds has helped drive yields on the bonds sharply lower in recent weeks, as fund managers bid aggressively for securities.

A yield index of 100 junk bonds tracked by KDP Investment Advisors closed at 10.34% on Monday, down from 11.29% on Feb. 22. The index is at its lowest level in more than one year.


Falling yields have boosted the value of existing junk securities, in turn helping returns on junk bond funds to rebound. The average total return (interest earnings plus net share price change) of junk funds year to date was 0.8% as of Thursday, according to Lipper Inc.

By contrast, many other bond fund categories have negative total returns so far this year, as yields on higher-quality bonds (especially U.S. Treasuries) have risen even as junk yields have declined.

Air carrier Northwest Airlines Corp. and clothing maker Perry Ellis International Inc. are part of a flood of junk-rated firms selling new debt to take advantage of rising demand.

Investors are hungrier for junk debt in part because strong economic data suggest that fewer junk-issuing companies will be at risk of default. Defaults soared last year as the economy fell into recession and more companies struggled to pay their bills.

Junk bond yields still are historically high relative to other interest rates, reflecting the risk that the economic recovery will falter, analysts said. The KDP yield index now is more than five percentage points above the yield on 10-year Treasury notes. In mid-1999 the “spread” between the KDP yield and the 10-year T-note was 4.10 percentage points.

Heavy buying of junk bond funds shows that “people are making a bet that the market has bottomed,” said Brendan White, a fund manager at Fort Washington Investment Advisors Inc., which manages $1.1 billion of junk assets.

With the window open for junk-rated companies to issue new debt, total junk offerings last week almost doubled from the prior period, to about $3.1 billion. Investors suddenly are finding that there’s not enough new supply to go around.

For instance, fund manager Kurt Havnaer tried to buy $2 million of a $300-million offering from Graphic Packaging Corp. last month for the high-yield assets he helps manage at Columbia Management Co. Demand was so strong that the banks managing the sale allotted him just $500,000, he said. “There’s so much demand for new issues, the allocations are not very good,” Havnaer said.

But the rate of junk fund cash inflows may not last, some analysts warn. Many market timers play junk funds for quick returns.

“Unfortunately some of this could be the hot money, that may go back out a week later,” said Martin Fridson, a high yield bond strategist at Merrill Lynch. “It’s not unusual to see a couple of weeks where it’s realistic to suppose the money is a lot of market timers.”


Invesco Funds Group has replaced Trent May and Doug McEldowney as managers of Invesco Growth Fund, which lost 49% last year and ranked in the bottom 1% in its sector. Invesco said the fund will be managed by Timothy Miller, Peter Lovell and Fritz Meyer, other growth-fund managers at the firm.