High-yield bonds worth the risk, fund manager says
With interest rates at near-record lows, these have not been good times for investors looking to generate low-risk income.
Money-market accounts are paying an average of 0.5%. (Think about that: A $1-million deposit into an average money-market will yield a whopping $5,000 a year.) Even five-year CDs are yielding just 1.5% on average.
So, where’s an income-hungry investor to turn? One option is high-yield bonds, which are paying about 6% but carry risk that issuing companies may default, eroding the bonds’ value.
Jim Keenan, who manages the $9.3-billion BlackRock High Yield Bond Fund, said bonds issued by companies with less-than-perfect credit ratings are a good investment because they provide equity-like returns with lower risk. His fund has a yield of about 5.9%.
“Today, if you’re cautious and want to protect your wealth you’re going to get a real negative result if you sit in cash,” Keenan said. “The value of the dollar is 2% to 3% less every year. Sitting in cash is to some degree a destruction of the value of your currency.”
High-yield bonds, typically referred to as junk bonds, are from companies with troubled credit ratings. In order to attract investors, these companies offer higher interest rates to bond holders.
Keenan, 36, supervises a team at BlackRock’s New York office that searches for bargains in these beaten-down brands. The fund returned 17% for the first three quarters of 2012, if dividends were reinvested in the security.
Including dividends, BlackRock’s high-yield bond fund has averaged a 23% annual return since March 2009, nearly keeping pace with the S&P; 500 stock index, which has soared an annualized 26% in that span.
Before joining BlackRock in 2004, Keenan worked with Columbia Management Group and UBS Global Asset Management. He has worked with the BlackRock High Yield Bond Fund since 2004 and served as its lead manager since 2008.
Keenan earned a bachelor’s degree in finance from the University of Notre Dame, where he played four seasons on the lacrosse team. He lives in Rye, N.Y., with his wife and four children.
With interest rates so low, should investors consider high-yield bonds as a good source of income?
You should have a diversified portfolio and think about risk across the board. High yield is a very good asset class to diversify into. In an environment where there’s not a tremendous amount of growth, many high-yield bonds look attractive to get 6% or 7% where most bonds are 1% or 2%. High yield is a good place to be on a risk-adjusted basis.
Yields are going down, even for high-yield bonds. At what point is the reward not worth the risk?
We were used to getting much higher returns because it was a different economic environment. Five hundred basis points [5%] today is attractive based on my view of the economic outlook. In 2007 or 2008, that would have been too little. We have to look at the market and weigh what is the probability of an economic downturn.
Since companies can default or go bankrupt, isn’t there a risk in lending to companies offering high-yield bonds?
When we lend to a company, we look at the risk-reward. We have to say, “What is the probability that this company won’t be able to pay back on the debt?” If that probability increases, we have to charge a higher risk premium. The high-yield market has stressed and distressed companies. There are also companies that are very, very good businesses.
What are some sectors you like?
We are overweight oiI companies. I think the central bank policy is holding energy prices at higher levels. And $80, $90 oil is completely healthy for these companies to pay back debt. We started to build an investment in autos in 2009 and have continued to do it, mostly in auto parts and [auto loan company] Ally Financial Inc. Auto loans are different than housing. They have a traditionally low delinquency and default rate. If you default on your auto loan, your car gets repossessed. It’s more difficult to do that with a house.
Your fund is underweight on banks. Why is that?
We do think the banks are getting better. The stimulus and the aid have been de-risking the banks. That being said, the business models are changing dramatically and there’s less visibility to the earnings. You don’t have the transparency of what’s earning the income for them. I prefer to invest in something with more visibility. An energy company has more visibility and certainty to their cash flows than some of the banks.
You played four seasons on the lacrosse team at Notre Dame and one season of basketball. How has playing team sports at a high level translated to Wall Street?
In college sports, you’re practicing with a group of guys every day and the team is more important than any individual. I take the same views with my team here. We work together every day to try to create alpha for the clients that invest in our funds.
