Newspaper article St Louis Post-Dispatch (MO)

Remember: They Call Them Junk Bonds for a Reason

Newspaper article St Louis Post-Dispatch (MO)

Remember: They Call Them Junk Bonds for a Reason

Article excerpt

Does anyone remember what happened to high-yield bond funds during the last recession?

Apparently not.

These days, high-yield bond funds (also known as junk bond funds) are the toast of the fixed-income side of town. The reason: High-yield bond fu nds have gained 16 percent annually since 1991, vs. only 7.2 percent for high-quality corporate bond funds. Junk funds have done almost as well as stock funds, which have gained 17.2 percent during the same period. Before you jump into junk, however, think back to 1990 when many junk bond fund investors suffered losses of 18 percent or more. Often, those investors bought shares in junk funds with the understanding that their money would be safe - after all, the funds held bonds, didn't they? Trouble is, high-yield bonds also can carry a high degree of risk. The reason: They invest in bonds of companies that have credit ratings below investment grade. Such companies generally are in mediocre or even bad financial condition. Most companies that issue high-yield bonds are perfectly capable of making timely interest and principal payments to bondholders - as long as the economy is relatively strong. But a sharp economic downturn or an industry setback can raise questions about their ability to keep doing so. That's when the bonds of some issuers - especially the most marginal - can plummet in price. During the last five years, the economy has been strong. What's more, bond market fluctuations have been driven largely by interest rate moves, which typically have a greater impact on investment-grade bonds with relatively low yields. Thus, junk bonds have delivered higher returns - and have been less volatile than supposedly safer government or blue-chip corporate bonds. No wonder junk funds are popular. But what happens when the economy stumbles and junk bonds take a beating? If history is any guide, shareholders in junk funds might rush to get out of the high-yield market. That would force funds to raise cash by disgorging their bond holdings, driving prices down even further. Such a downturn could be a great buying opportunity - but only for investors who understand the risks and are willing to stay with the high-yield sector for the long term. …

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