High Tide for High Yield

Last July, Calpine was criticized for bringing a $3 billion issue to a saturated market. Earlier this month, Calpine came out with an additional $2.5 billion issue.

Tom Huggins, high-yield portfolio manager for Eaton Vance, does not see the influx of new issues rattling the markets too much because of the improved credit quality of the names. Huggins' fund returned 29.4% in 2003 through aggressive trading and a canny ability to choose winning CCC-rated bonds, especially in a telecom sector that was once left for dead.

"I think the quality of paper is very strong now and the asset class is not made up of Internet stocks with poor credit," says Huggins.

Whose Default Is It?

Most likely, the market will learn the true quality of the current wave of high-yield debt in three years. According to Martin Fridson, publisher of Leverage World, an independent high-yield strategy publication, default rates historically lag new issues by three years since "very few companies miss their first few coupon payments."

Like Slein, Fridson also sees a growing glut in the CCC range in today's market and is expecting default rates to rise in 2006-2007.

For the time being, Fridson is in the "priced to perfection" camp, but still sees high-yield bond funds as preferable to other fixed-income investments, especially in a rising interest rate environment.

"A sudden rise in short-term interest rates would cause the bond market as a whole to be hurt, but high yield would do better because the yield would cushion the fall. Long-term treasuries would fare the worst," says Fridson. "Higher interest rates might be a positive because that means there is faster earnings growth in the economy, and the economy is the most important element in high-yield debt."

For his part, Eaton Vance's Huggins is telling clients to disregard all the flak about high-yield bond prices being "priced to perfection," because prices, like performance, are all relative.

"Clearly, nobody would argue that high yield is as compelling as it was a year ago, but I think you can expect the coupon of around 8%, and I don't think that looks bad on a risk-adjusted basis vs. equities. If we make some good moves, we might make a 10% total return, which is still pretty good."

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