Dessauer: in the Vanguard

10/23/2002 12:00 am EST

Focus:

John Dessauer

President, John Dessauer Investments, Inc.

Looking for a 9% yield and the potential for additional capital gains? John Dessauer has the answer – a high-yield bond fund. And this fund has lower fees, better management, and less risk than its peers. Here his review from the latest Investor’s World.

“Here’s a new idea for income, plus growth: Vanguard High-Yield Corporate Bond Fund. Junk bonds are ‘equity equivalents’ because they are not much higher up the risk ladder than common stocks. Therefore, junk bonds can, when the time is right, be a logical addition to our portfolios. On the other hand, they can become as worthless as common stocks when there is serious financial trouble. In the late 1990s, there was a rash of junk bond issues by risky start-up companies. That went hand in hand with the tech stock bubble. The result was that the default rates on junk bonds soared from 2% in 1998 to 9.6% recently. Naturally, investors rushed out of junk and prices have collapsed, along with stock prices, setting up a rare opportunity.

“Meanwhile, as a result of recent corporate failures, the junk bond market has been transformed. Only solid companies can sell bonds today. Future default rates are very likely to go back down to the 2% level. That in turn will lift junk bond prices. This is a case where observing the crowd’s behavior and taking advantage of it is likely to produce not just a 9% yield but solid capital gains. We note that the fund does not offer the highest yield, because higher yields go along with higher risks. It buys lower-risk junk bonds.

“Vanguard High Yield Corporate is especially attractive because of its low cost and superb management. The cost is just 0.27% a year and the same manager - Earl E. McEvoy - has run the fund since inception in 1984. What can we expect from this fund? The current yield is 9.4%. That gives us a cushion while we wait for the recovery. When it comes, profits could be better than you might expect. Junk bond funds do well coming out of a recession. In 1991-1993, the cumulative return for this fund was 74% in three years. Could we be headed for a repeat of those years? Yes. Inflation is low and it will stay low. As the economy recovers, the Federal Reserve will raise short-term interest rates to 3%. That will help, not hurt, junk bonds. High-quality bond prices go down when interest rates rise, but that is not usually the case for junk bonds. They do best when business and the economy are doing well and there is no serious inflation. We are headed into just such an environment. Buy the Vanguard High-Yield Corporate Bond Fund.” The fund can be reached at 877-662-7447.

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