Junk Bond Funds Doing Fine

Sat., Jan. 18, 1997

Chet Currier Associated Press

While stocks have been the big stars of the 1990s bull market on Wall Street, any investor in junk bond mutual funds knows they haven’t been the whole story.

For the last six years, funds that invest in higher yielding, lower quality debt securities have been rolling up gains at better than 12 percent a year.

That’s not quite in the same league with domestic stock funds’ 16 percent-plus returns, as reported by Morningstar Mutual Funds in Chicago. But it’s still a dazzling performance over a sustained period.

By comparison, funds investing in higher quality long-term corporate bonds have returned 8.77 percent a year over the five-year period ended Nov. 30, Morningstar reports. The junk bond funds’ gain actually outpaced international stock mutual funds, which averaged an 11.18 percent gain per year.

What makes their rise even more impressive is its humble origins. In both 1989 and 1990, high-yield funds took a beating as junk bonds struggled through a recession and the collapse of their market’s mainstay investment firm, Drexel Burnham Lambert.

Since that time, however, the junk bond market has come on stronger than ever before as a financing medium for newer and smaller companies - as well as a home for debt securities whose issuers’ credit ratings fall below “investment grade.”

With the help of continuing growth in the economy and relatively easy credit conditions, junk bond issuers have generally prospered, rewarding investors willing to take greater default risk in return for higher yields.

And that good performance has attracted additional investment. Morningstar now tracks some 164 junk bond funds with $70 billion in assets, which compares pretty favorably to $125 billion in all types of government bond funds.

All this happy news has reached the point, however, where some analysts and managers have turned wary.

After a long decline to very low levels, they say, the rate of defaults by junk bond issuers may be starting to creep up again. While enthusiasm for junk bond investments has mounted, their yield spreads - or the extra interest returns they offer in comparison with blue-chip alternatives such as Treasury bonds - have narrowed.

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