Fidelity High Income: Resurgence in Junk

08/18/2016 9:00 am EST

Focus: FUNDS

John Bonnanzio

, Funds Net Insight

On the heels of a disappointing 2015, high-yield (junk) funds are enjoying a resurgence. Most of Fidelity’s varied offerings have scored equity-like returns -- with much less risk than stocks, states John Bonnanzio, editor of Fidelity Monitor & Insight.

Fidelity High Income Fund (SPHIX), which we hold in both our Growth and Income and Income Model Portfolios, has been a homerun.

With junk generally less interest-rate-sensitive than they are economically-sensitive, concerns last year that the US economy was heading toward a recession sapped demand and weighed on their performance.

That’s because financially troubled companies are more likely to default on their loans when the economy is weak.

Another, less obvious headwind for junk bonds last year were slumping oil prices. With a barrel of crude falling about 50% from its 2015 peak, many small to mid-size oil and gas service providers found their balance sheets under severe duress.

With about a third of all junk issuance tied to the energy sector, Fidelity’s high-yield managers had few options apart from simply hanging on.

Good thing they did! In February of this year, a barrel of crude had fallen to below $30, and high-yield continued to pay the price.

But by May they had rebounded to above $50, thereby providing the energy sector with a lot more breathing room.

The risk of defaults in this sector started to lessen. In addition to that, the economy avoided recession and continued to mend, albeit slowly and unevenly, reducing default risk in general. As junk bonds came under pressure last year, their yields rose.

On the other hand, with central banks around the world cutting their interest rates (sometimes to below zero percent), long-term US Treasury bond yields declined.

With Treasury yields reaching all-time lows, the far higher yields on junk bonds were looking very attractive indeed.

The allure of High Income’s 6.33% yield is obvious in absolute terms. But when contrasted to other classes of fixed-income bonds (such as taxable Treasuries and tax-exempt munis), junk funds look even better.

Investors shouldn’t ignore the inherent risks of holding any junk bond fund. They are significantly riskier than taxable and muni bond funds. But, with that in mind, their overall risk-to-reward characteristics are presently attractive.

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By John Bonnanzio, Editor of Fidelity Monitor & Insight

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