Average ‘Junk’ Bond Yield Falls Below 7%

The latest powerful rally in corporate “junk” bonds drove the average yield on the securities below 7% on Tuesday, the lowest level since at least the 1970s.

The plunge in the bonds’ yields over the last year is a measure of investors’ strong appetite for junk securities, so named because they are issued by companies considered below investment grade in quality. As the prices of fixed-rate bonds are bid up, their yields fall.

But some analysts warn that the skimpier returns on junk bonds leave little room for error should the economy stumble or if many investors decide to exit for some other reason.

On Tuesday, the average annualized yield on an index of 100 junk bonds tracked by KDP Investment Advisors dropped to 6.97% from 7.09% on Monday.

The yield on the index, created in 1990, had never been below 8% until late last year.

Other indexes of junk bonds also show yields at their lowest levels since the modern junk market was created in the 1970s.

A year ago, investors demanded yields of more than 10.5% to buy junk issues. But the economy’s strong rebound in 2003 boosted confidence in the financial health of the companies behind the bonds.

Though many junk-issuing firms were forced to file for bankruptcy protection as the economy struggled in 2000 and 2001, the risk of default -- when a company fails to make interest payments owed investors -- has been declining since January 2002, according to Moody’s Investors Service in New York.

Kingman Penniman, head of junk bond research at KDP in Montpelier, Vt., said many investors continue to gravitate toward junk securities because the yields, though low historically, still are well above what’s available on Treasury bonds and other higher-quality securities.

“I think the view is, ‘If you’re going to be in fixed income, you have to be in high yield,’ ” he said.

But as junk yields fall, “it brings into question whether investors are being adequately compensated for the risk,” said John Lonski, economist at Moody’s in New York.

He and other analysts noted that market “timers” have long been a big force in junk bonds and can be quick to sell if they sense the tide turning.

“The margin for error in the high-yield market has declined” with the yields, Lonski said.