High yield bonds, often known as junk bonds, have been very popular investments since the financial ...
High Yield Still Has Room to Run
03/17/2010 11:31 am EST
Benjamin Shepherd, associate editor of Personal Finance, likes a bond fund that’s finding good high-yield opportunities all around the world.
High-yield bonds were the best performing fixed-income category in 2009, as funds structured around these instruments generated an average return of better than 46%, according to data compiled by Morningstar.
This marked a sharp turnaround from 2008, when the market regarded any company relegated to the high-yield category as essentially bankrupt; high-yield bond losses for the year were exceeded only by bank loans.
Spreads over Treasuries, which climbed as high as 21.82 percentage points during the worst of the financial crisis, have tightened to around seven points as investors have rediscovered their risk tolerance. The fact that many investors are basically being forced to reach for yield certainly hasn’t hurt matters.
Even this recovery still puts spreads above the 4.5-percentage-point long-term average; prices for high-yield bonds still have room to rise. Two years after the official conclusions of the past two recessions, high-yield bonds gained better than 80%.
This, too, suggests there’s room to run. Interest rates will inevitably rise, and high-yield bonds tend to perform well during tightening cycles. While Treasury yields increased from 2.3% in June 2003 to 3.9% in June 2004, high-yield bonds gained 14.2%.
Finally, the overall economic environment continues to improve, and speculative-grade credits’ access to financing is increasing along with profitability; speculative-grade default rates are expected to slow from a peak of 12.9% in November 2009 to just 3.3% over the course of this year. This less ominous risk forecast should help tighten spreads.
Despite last year’s huge run and the slow start to 2010, this should be a solid year for Carl Kaufman and Osterweis Strategic Income (OSTIX). Categorized as a multi-sector bond fund, it’s currently invested primarily in lower-rated bonds (which make up almost 80% of the portfolio) with shorter maturities.
Kaufman is poised to benefit from tightening credit spreads over the course of the year.
He’s also upped his stake in convertibles—the prices of which behave more like stocks than bonds—to 14%, positioning the fund to benefit from a further improvement in equities.
Kaufman has also shifted assets to foreign corporate debt. His largest holding is Millicom International Cellular 10% Note of 2013, which is fairly representative of typical Kaufman investments. This bond, like many of Kaufman’s holdings, is unrated.
Millicom International Cellular (Nasdaq: MICC) has reported robust growth in Africa and South America; it’s now the leading provider by market share in Honduras, Paraguay, El Salvador, and Guatemala.
During its most recent quarter, revenue rose 27% in Africa and 15% in South America, for overall growth of 9%. Cash flows provided ample coverage for company debt-service payments.
With a yield of 6% and strong underlying assets, Osterweis Strategic Income is a solid Buy for the long term.
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