Home' Trinidad and Tobago Guardian : May 18th 2014 Contents SBG22 INTERNATIONAL
SUNDAY BUSINESS GUARDIAN www.guardian.co.tt MAY 18 • 2014
Junk bonds have been strong
investments since the reces-
sion, and investors continue
to pile into the market. But
fund managers say they re
looking less attractive. Many
are taking a step back and
urging investors at least to
temper their expectations.
The big run for junk bonds came as
investors clamored for better interest rates.
The Federal Reserve has helped keep interest
rates low, which gives the economy a boost
but also limits the interest income generated
by bonds. To make up for that, investors have
turned to bonds from companies with lower
credit ratings that carry a higher risk of
Junk bonds are also called high-yield bonds
because they have to pay higher interest rates
to make up for their increased risk. Demand
has been so strong that the price of junk
bonds has jumped significantly. That s making
many investors question if their yields are
"High-yield (bonds look) pretty pricey,"
says Kris Kowal, a managing director who
oversees US$10 billion in investments at
DuPont Capital Management. Junk bond
yields are close to 5.0 per cent, down from
greater than 20 per cent during the financial
crisis of 2008. "Do you want to lend money
to some of these high-yield companies at
5.0 per cent? I don t know."
As investments in Kowal s junk-bond port-
folio mature, he s moving much of the money
to other parts of the bond market.
To be sure, last year many fund managers also called
for caution, yet junk-bond funds delivered more gains.
The average high-yield bond mutual fund returned
5.5 per cent over the last 12 months, making it the
leader among the 32 types of bond funds that Morn-
Bond-fund managers also say that junk bonds con-
tinue to look more attractive than other types of bonds.
And defaults have not been a problem: the default
rate was 1.7 per cent last month, up slightly from 1.6
per cent in March, which was its lowest level since
the financial crisis.
"We still like high-yield relative to other sectors,"
says Matt Pallai, portfolio manager at the JPMorgan
Multi-Sector Income fund. "Prices are just very high.
There s not a lot of room for error."
With prices so high and volatility low, Pallai says
the junk-bond market could quickly turn jumpy if
confronted with any surprises. That s one reason his
fund has cut the amount it has in junk bonds over
the last couple months.
Junk bonds are down to 40 per cent of the portfolio
from 50 per cent, and most of the money that the
fund has pulled from high-yield bonds has gone into
Among the warning signs that are flashing for high-
• Investors are earning less of a premium over safer
When considering a bond, investors don t look at
just its yield. They also check how its yield measures
up to a Treasury bond maturing around the same
Junk bonds have recently offered about 3.7 percentage
points more in yield than similar Treasurys. That s
lower than the average difference of 4.3 percentage
points over the last 12 months. Over the last five years,
the average spread has been 6.0 percentage points.
That means investors are getting paid less of a pre-
mium to take on the added risk of default that a junk
• Protections for investors are weaker
When companies issue bonds, they agree to certain
restrictions with investors. These restrictions, which
lawyers call covenants, can put a cap on how much
debt a company can take on, for example.
Since 2011, Moody s has been keeping a monthly
tally of how strong the protections are for investors
who buy bonds issued by junk-rated companies. The
rise in demand for junk bonds means that companies
with low credit ratings have generally faced more lax
restrictions when borrowing money.
Moody s measure of covenant quality fell to a record
low in February, though it has improved a shade since
Despite the increased warning signs, investors con-
tinue to pour into junk bonds. High-yield bond mutual
funds took in a net US$5.3 billion through the first
four months of this year. That s more than triple the
US$1.5 billion investors put into intermediate-term
bond funds, the largest bond-fund category with triple
the assets of junk-bond funds.
In coming years, those investors can likely expect
lower returns than high-yield bonds have offered.
Over the last five years, high-yield bond mutual funds
have posted an average annual return of 13.6 per cent.
Looking ahead, a more fair expectation is closer to the
current yield that the bonds offer, say 5.0 per cent,
according to managers.
Investors should also keep in mind that junk bonds
can have sharp swings due to their increased risk. In
2008, for example, the average high-yield mutual fund
lost 26.4 per cent, compared with a 4.7 per cent drop
for intermediate-term bond funds. AP
Warning signs are flashing
for junk-bond investors
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