Path: bloom-picayune.mit.edu!snorkelwacker.mit.edu!americast.com!americast.com!americast-post Newsgroups: americast.forbes From: americast-post@AmeriCast.Com Organization: American Cybercasting Approved: americast-post@AmeriCast.com Subject: THE FUNDS Date: Wed, 18 Nov 92 14:52:03 EST Message-ID: "Copyright 1992 Forbes, Inc. Any further reproduction or redistribution without the express written permission of Forbes and ACC is prohibited." THE FUNDS Hot junk Junk bond funds took a beating last month. Is their long recovery over? Or is this a buying opportunity? By Riva Atlas AFTER A BUYING SPREE that had been going on for nearly two years, inves- tors reversed in October, redeeming more than $1.9 billion in junk bond shares. It was a virtual stampede, ac- cording to figures from AMG Data Services of Arcata, Calif. Vanguard High Yield Bond Portfolio lost $531 million in net redemptions-or more than a quarter of net assets-in Octo- ber; T. Rowe Price High Yield had $239 million in net redemptions; Fi- nancial Bond Shares, $95 million in net redemptions. The stampede had a beneficial side effect: It made junk bonds a little cheaper for today's buyers. The aver- age junk yield climbed to 4.3 percent- age points over ten-year Treasurys at the end of October, up 41 basis points from the gap at the end of August. Remember, too, that Treasury yields were moving up as the market began discounting Bill Clinton's victory. Much of last month's outflow was triggered by market-timing invest- ment advisers, who had bought large blocks of junk fund shares during the rally. By October the average junk fund's rise of 16% looked so good that these hot-money managers decided to lock in their returns. As a result junk bonds took a heavy hit. The Salomon Brothers Extended High Yield Market Index of junk bonds (including both high- and low- grade issues) was off over 2% in price for October. The junk market is espe- cially vulnerable to mutual fund re- demptions because junk funds are such an important part of the junk market. Mutual funds own at least 30% of all junk bonds, estimates Jo- seph Bencivenga, head of corporate bond research at Salomon Brothers. For smart investors, the selloff rep- resents opportunity. The high-yield bond market is healthier than it's been in almost three years. In the third quarter of 1992 the rate of companies defaulting on debt dropped to 0.2%, far below 4.2% in January 1991. In the first nine months of 1992, a refinancing boom set off by lower interest rates retired 11% of the high- yield market. Many of the better com- panies have already refinanced most of their higher-cost debt, and with interest rates on new junk bond issu- ers trending toward 13%, the cost of issuers' replacing their old bonds has become less attractive. That helps ex- plain why more than $2 billion in prospective junk bond deals were re- cently pulled from the market. That has left the new issue market increasingly weighted toward bonds that finance acquisitions and capital expenditures. Riskier than refinanc- ings, the new junk is still far stronger than the paper issued in the late 1980s, says Gregory Smith, president of Indepth Data. In the third quarter, the companies issuing new junk bonds averaged free cash flow (income before deprecia- tion, interest and taxes, but after capi- tal expenditures) of 1.7 times interest. The comparable figure was 1.4 in 1992's first quarter, and many deals in 1989 had coverage ratios between 0.8 and 1.2. ''From a fundamental stand- point there's absolutely nothing wrong with the market,'' says King- man Penniman, head of high-yield research at Duff & Phelps/MCM. As spreads between Treasurys and junk widen, bargains are popping up. ''Every tier of the market is trading at unjustifiably low [price] levels,'' says Daniel Harmetz, comanager of the $1.7 billion Fidelity Capital & In- come Fund. Harmetz likes such high- quality junk as General Nutrition's 11 3/8% senior subordinated notes, re- cently trading at 102 1/2, down from 104 1/2 at the end of September, and Embassy Suites' 10 7/8% senior notes, down from 105 to 100 1/2. The table shows five funds that have combined good returns over the past five years with low expense ratios and loads. If the economy rebounds in 1993, the lowest-grade cyclical junk should perform best. If you fore- see a soft economy and slack interest rates, get a fund of higher average credit quality. Either way, junk bonds look like a good place to be right now for yield-hungry investors.  "This information is the property of Forbes, Inc., ACC takes no responsibility for its content, or the actions of any individual or institution, predicated on the information herin. 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