Junk Bonds Could Rally in Sluggish Economy

PORTSMOUTH, N.H. (TheStreet) -- Mary Austin, manager of the Pax World High Yield Bond Fund(PAXHX), says the economy's slow recovery and a slew of new issues could bring big returns to junk bond investors.

The $388 million fund, which has earned four stars from Morningstar(MORN), has returned 26% during the past year, trailing its category by 11 points. However, the fund has gained 4.3% annually, on average, during the past three years, beating 83% of rivals.

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What can you expect from junk bonds in 2010?

Austin: We believe the weak economic outlook, slow recovery and low interest rate environment forecasted for 2010 should bode well for the high-yield market. Although spreads have tightened more than 1,000 basis points from 2008 -- when many thought the world was on the brink of financial disaster -- we believe there is still room for spread tightening and positive total returns in 2010. Although we do not forecast returns, Credit Suisse(CS) has estimated high-yield total returns for 2010 to be between 10% to 14%.

We believe much of the improvement in the high-yield market stemmed from the opening of the new issue market in April 2009, following an eight-month hiatus. Refinancing helped to improve liquidity, push out debt maturities and lift restrictive covenants. We think investors became more comfortable with the high-yield market and the belief that many companies, especially those on the fringe, might have enough reserves to get through the tough times.