High Tide for High Yield

Successful bargain hunters typically outfox their competitors by arriving early on the day of a big sale. Likewise, deal-seeking investors who started shopping in early 2003 for high-yield bond funds brought home the lowest prices and the highest yields. Those investors who owned high-yield funds the entire year were rewarded for their diligence with an average return of 24.04%.

On the other hand, investors who arrived late to the market found themselves caught in a stampede of yield-starved investors running from the 10-year Treasury note. In June of 2003, the (VWEHX Quote - Cramer on VWEHX - Stock Picks)Vanguard High-Yield Corporate fund closed its doors to new investors after being overrun with new, and possibly hot, money.

Now that the great yield rush has ended, the prevailing view among analysts is that high-yield bonds, or what are sometimes called "junk bonds" because the corporate debt is considered to be a higher credit risk, are "priced to perfection." But does that mean it's time for savvy shoppers to start looking for bargains elsewhere?

Priced to Perfection

Most analysts agree that over the last year to 18 months, much of the capital appreciation in the high-yield market has been wrung out. According to the Lehman Brothers high-yield index, the spread between high-yield bonds and the 10-year Treasury bond shrank from 842 basis points, or 8.42%, on March 10, 2003, to 439 basis points, or 4.39%, on March 8, 2004.

The tighter spread begs the question as to whether investors are willing to stomach the additional risk involved with high-yield bonds in return for the slim reward of earnings just 4.39% above a 10-year Treasury note, now hovering in the 3.75% range.

Morningstar Analyst Scott Berry agrees that the high-yield market is probably "priced to perfection," but in today's low-yield environment, Berry says yield-seeking investors have few alternatives.

"You are getting very little yield from diversified bond funds," says Berry. "So just taking home the 6% to 7% yield from high-yield funds may be attractive."

Littered With Junk Bonds U.S. High Yield Issuance (in billions)
2004	$30.9*
2003	131.2
2002	58.8
2001	78.9
2000	42.7
1999	92.7
* Through March 12. Source: Bloomberg

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