Junk Bonds Smell Better After Exodus

7/11/2011


High-yield corporate bond funds have experienced five straight weeks of outflows through June 29, as investors fled from risky assets. But the rush into higher-quality bonds could position high-yield (junk) bonds for a nice run in coming months.

About $2.9 billion flew out of U.S. high-yield bond mutual funds in the week ended June 22, according to Lipper FMI, the largest weekly outflow since at least 1992. Add exchange-traded funds to the mix, and the outflows reached $3.4 billion. The spread between 10-year Treasury notes and junk bonds serves as another sign of investors shunning risk. At 4.3%, the spread is close to its highest point since November, though it falls well short of the monthly average of 6.0% since 2000, which is skewed by huge junk-bond yields in late 2008 and early 2009.

Investors' recent stance marks a shift from attitudes earlier this year. High-yield bond mutual funds took in roughly $7 billion in new money during the first two months of 2011, according to Morningstar. For all of 2010, investors poured $7.6 billion into such funds.

Bond yields generally move in the opposite direction as prices, so the recent rise in yields makes junk bonds more attractive. The selloff has lifted the yield to 7.4%, its highest level in 2011. The yield had slumped to a record low of 6.8% in May. But the current yield remains well below the financial-crisis peak of 22% in November 2008.

Income investors seeking attractive yields have few other alternatives. Among the major asset classes, only junk bonds and preferred stocks yield above 7%. The 10-year Treasury yields 3.1%, well below the average of 4.3% since 2000. And investors shouldn't expect stocks to take up the slack, with the S&P 500 Index yielding just 1.9%.

Macroeconomic factors could also tilt the odds in favor of junk bonds, which are more likely than other types of bonds to benefit from higher stock prices. Japan continues to recover from the disaster, while Greece's adoption of austerity measures seems to have calmed the markets. Although the U.S. recovery appears to be slowing down, the economy still seems unlikely to slip into a recession.

HIGH-YIELD FUNDS
Total Return
Fund (Price; Ticker)
Est.
Yield
(%)
YTD
(%)
12
Months
(%)
3 Yrs.
(Ann.)
(%)
Exp.
Ratio
(%)
Exchange-Traded Funds
iShares iBoxx $ High Yield ($91; HYG)
7.8
4.4
15.8
8.9
0.50
PowerShares Fundamental HY
Corp. Bd. ($18; PHB)
6.8
4.7
12.9
2.4
0.50
SPDR Barclays Capital High
Yield ($40; JNK)
8.3
4.6
15.9
9.4
0.40
Mutual Funds
Fidelity Capital & Income
($10; FAGIX)
6.2
5.6
22.0
13.9
0.76
T. Rowe Price High-Yield
($7; PRHYX)
7.6
4.9
16.0
11.2
0.76
USAA High-Yield Opportunities
($9; USHYX)
7.1
5.9
17.6
12.6
0.96
Wells Fargo Advantage High
Income ($8; STHYX)
6.8
5.0
15.2
10.0
0.93

Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com