Coupon Clippers Eye High-Yield Funds

The moribund stock market, "measured" rate increases and unpredictable economic growth have surely flummoxed many investors this year. But that could mean happier times for holders of high-yield bond funds.

Shaking off a rocky start, the average high-yield bond fund is up 5% this year. Now many fund managers are saying the slowly expanding economy has entered the perfect environment for high-yield bonds.

"From terrorism to oil to the election, it seems like there is no catalyst to get people to buy stocks," says Bruce Walbridge, co-portfolio manager for the (SSHYX Quote)State Street Global High Yield Bond fund. "So now they are willing to take the additional risk to pick up some extra yield."

"High-yield is the place to be in a slow recovery," says Cynthia Cole, director of corporate bonds at the Armada Funds. "Companies will be strong enough to make their coupon payments. But they won't be doing so well that investors will switch back to stocks."

Whether they were spooked by the threat of rising interest rates or just looking to take money off the table -- high-yield funds posted an average gain of 24% in 2003 -- high-yield fund investors spent the first half of 2004 running for the hills. High-yield funds averaged $1.76 billion in outflows through May, including a $5 billion redemption blast that month, according to fund tracker AMG Data.

But with growth expectations cooling as the year has gone on, investors have grown hungrier for fund yields now averaging close to 8%. That's especially the case when the 10-year Treasury is yielding a paltry 4% or so.

Since the May blowout, net inflows have crept upward from $208 million in June to $787 million in August. AMG says September inflows are closing in on $400 million, making it likely the market will be seeing a fourth positive month in a row.