Don't Trash Those Junk Bonds

These might be the worst of times for high-yield bond funds, but that's also why they're worth a look.

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High-yield, or junk, bond funds invest in bonds issued by companies -- often tech and telecom shops -- with less-than-perfect credit. Thanks to recession worries, a downtick in corporate spending on tech and telecom equipment and the looming threat that more of the upstart telecom firms will fold without paying their bondholders, these funds have had rough time. The average high-yield fund has suffered an annualized loss of 1.4% over the past three years, according to Morningstar. In 2000 the average fund dropped more than 9%, more than any other bond-fund flavor.

"I think a lot of the bad news is already priced in to high-yield bonds," says Scott Berry, a bond fund analyst at Morningstar. "Even if the economy has a hard landing, I think these bonds should do OK this year. Some analysts are calling for 20% or 30% returns, and I'm not in that camp. But I think folks might make back what they lost over the last year and maybe some more."

What are bonds? For details, check out our basics section's primer on bonds, junk bonds and bond funds.

High Times? High-yield bond funds may be poised for a solid 2001
	Avg. High-Yield Bond Fund	S&P 500
YTD Return	4.1%	-0.1%
1-Year Return	-4.8	-6.9
5-Year Return	3.9	18.8
10-Year Return	10.0	18.0
Source: Morningstar. Annualized performance figures through Jan. 16.

Amid all this bad news for high-yield funds, there may be a silver lining. Investors may have gotten too negative, leading savvy investors like Bill Miller and Ken Gregory to name high-yield bonds as a great opportunity over the next three years. Both believe today's high-yield bond prices are too low, and if falling interest rates coax more investors to dip a toe into the high-yield market, they could be proved right. Consider that so far this year the average high-yield fund is up more than 4%, beating all fixed-income categories and all stock fund categories, aside from communications funds.

So even though these funds shouldn't be your core bond holding, they should be part of a diversified portfolio and now might be a good time to add one. To help you see what's out there, we've done some homework by screening the category to single out funds that beat their average peer over the past one-, three- and five-year periods, with the same manager or managers at the helm. To make our cut, funds also had to have below-average expenses. Fees matter even more for bond funds than stock funds because they tend to have lower returns.

Only 15 funds cleared our hurdles: Here's a top-10 list, ranked by their five-year returns.

Leading High-Yield Bond Funds
Fund	5-Year Annualized	3-Year Annualized	1-Year Return
(CMHYX Quote)Columbia High Yield	7.4%	4.8%	7.8%
(PHIYX Quote)PIMCO High Yield Instl	7.1	3.6	3
(LBNDX Quote)Lord Abbett Bond Debenture A	7	3.8	4
(FHYPX Quote)INVESCO High Yield Inv	6.6	0.9	-4.2
(VWEHX Quote)Vanguard High Yield Corporate	6.2	3	3.3
(NTHEX Quote)Northeast Investors	5.9	-0.3	-3.1
(SAHYX Quote)Salomon Bros. High Yield Bond A	5.8	-0.3	-0.5
(OFHYX Quote)Offitbank High Yield Sel	5.7	1.6	0.4
(SHYAX Quote)SEI Instl. Managed High Yield	5.6	0.1	-3.6
(UNHIX Quote)Waddell & Reed Adv High Income A	5.5	0.7	-3.1
Avg. High-Yield Bond fund	3.9	-1.4	-4.8
S&P 500	18.8	13.4	-6.9
Source: Morningstar. Annualized performance figures through Jan. 16.

Conservative investors might look at the no-load (PHYAX Quote)Pimco High-Yield fund or the no-load (VWEHX Quote)Vanguard High-Yield Corporate fund. Both funds spread their assets broadly and include some higher-quality bonds along with riskier fare. That's helped them hold up better than their peers in down months over the past three years. Both funds lost less than 1% during last year's tumble.

The Pimco fund, run by Ben Trotsky since the fund's 1995 inception, is run by a firm known for its acumen at running bond funds. Pimco is home to Bill Gross, the bond guru who became the only fund manager to win Morningstar's Manager of the Year award twice. The fund has beaten at least 90% of its peers over the past one-, three- and five-year time periods. Its 0.75% expense ratio is well below its average peers' 1.3%.

Earl McEvoy of Boston-based Wellington Management has been at the helm of the Vanguard fund since 1984. If you're looking for a broad, lower risk fund this might be a solid option. The fund's minuscule 0.28% annual expense ratio is far and away the lowest among the funds on our list.

If you're looking for a more aggressive fund, check out the no-load (FHYPX Quote)Invesco High-Yield fund. In running the fund, portfolio manager Jerry Paul, Morningstar's 1999 Manager of the Year, typically makes big bets on companies and industries he likes. Many of those bets have been in the telecommunications sector that sagged last year. Despite that racy approach, the fund hasn't been more volatile than its peers over the past three years. Its 0.9% annualized return over that period might not knock you down, but it beats more than 70% of its peers.

There you have it, a short list of high-yield funds if your interest is piqued in this battered pack.

If you're in the market for a high-yield fund, a good rule of thumb in shopping -- which applies to all fund categories -- is to steer clear of funds with drastic outperformance and underperformance. A high-yield fund that has one great year, for instance, might have owned stock as well as high-yield bonds. A fund with a current yield that's way above the category's 11.7% average might also be a must-miss since that high yield probably reflects a risky portfolio.