Supercharged performance

High-yield bond funds make a comeback

This hasn’t been a great year for bond investors. Concerns over the robust economy and fears of rising interest rates have led to poor bond and bond fund performance. The average intermediate government fund had a negative total return of 1.75% through August 31, according to Morningstar Inc., a fund research firm in Chicago. However, high-yield bond funds managed to deliver a total return of 3.22% for the same period. (Total return is the interest earned by a fund, plus or minus any change in the fund’s value.)

High-yield bond funds are less sensitive to interest-rate moves than other bonds, according to industry sources. These bonds are more closely tied to the equities market, and their prices fluctuate with the health of the company backing the security, as much as on expectations for inflation and interest rates. High-yields bonds-also called "junk" bonds because they are rated below investment grade-are issued by companies rated BB or lower, as ranked by Standard & Poor’s.

Many of these companies are too small or too new to earn an investment-grade rating, while others are blue-chips facing financial difficulties. To make up for the increased risk that the company may default, these bonds pay higher yields compared with safer, high-quality government and investment-grade corporate bonds.

"High-yield corporate bonds yield almost two times the value of the comparable Treasury," says Steven Ruggiero, director of high-yield securities research at Chase Securities in New York City. "By historical standards, that’s high." According to the Merrill Lynch High-Yield Master Index, the average high-yield bond yielded 10.46% compared with 5.81% for the 10-year Treasury in mid-summer.

At the head of the pack of high-yield funds in the first half of this year was Dreyfus High-Yield Securities. Fund manager Roger King has delivered a 15.5% gain through June 30-and an eye-catching 14.92% yield-by loading up on bonds of telecom firms, which rallied early in the year, and convertibles of companies like satellite TV company EchoStar Communications Corp. (Nasdaq: DISH).

More than 54% of King’s holdings were in bonds rated below B. Analysts say that the average high-yield bond fund has just over 8% in bonds rated below B, making the Dreyfus fund quite risky. King says his fund is for investors seeking total return. The best way to do that over the long term is to purchase lower-rated credits, he adds.

In second place is Loomis Sayles High-Yield Fund, which had a total return of 11.73% and yielded 12% through June 30. The fund received much of its gain by buying blue-chip bonds in beaten-down emerging markets, according to Kathleen Gaffney, co-manager of the fund. The fund has approximately a 40% exposure to Asia and Latin America. The portfolio paid for the extra risk last year when investors fled high-risk securities because of overseas crises such as the Russian devaluation scare. Its total return was -8.87% in 1998.

Gaffney focused on telecommunications and utility companies in those countries. For example, Gaffney says

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