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There Is No High Yield 'Bubble' to Burst, Says Fund Managers

Stocks in this article: AGDAX MASAX FPNIX HYG

NEW YORK (TheStreet) -- For all the talk of a high yield "bubble" set to burst, most bond fund managers are disregarding it as, well, a load of junk.

"There are still advantages there, so we still have an overweight in that space," said Bob DiMella, portfolio manager for the MainStay Tax-Free Bond Fund  (MTFCX), adding that the "easy money has been made" in high yield so investors need to be more "tactical".

High yield's most obvious advantage is the extra cash it offers investors in the ongoing low-yield environment. The iShares iBoxx $ High Yield Corporate Bond ETF (HYG), for example, is currently yielding 5.7% compared to 2.5% for the 10-year Treasury note. Considering that yields in the sector were as high as 22% in late 2008, one can surely understand the argument that investors are not pocketing enough premium for the amount of risk being taken.

The HYG sank 2.7% in July, as investors who had streamed into the funds are now worrying if high yield bonds will be the first casualty if the Federal Reserve raises rates sooner than expected due to an improving economy. The S&P 500, by comparison, fell 1.9% over the past month, while the iShares Barclays 20+ Year Treasury Bond (TLT) has jumped 1.3%.

High-yield funds saw net outflows of nearly $1.5 billion for the third consecutive week as investors appeared concerned about valuations in the corporate bond non-investment-grade segment, according to fund tracker Lipper. Investors in July pulled more than $5 billion from junk-bond mutual funds and ETFs.

"The high yield market may be expensive, but it's not in a bubble," said Gershon Distenfeld, portfolio manager for the AllianceBernstein High Income Fund (AGDAX). "Bubbles are created when people chase after assets because they think they are going to get rich. People are not buying high yield funds to get rich. They are doing it because they need income and there is not a lot of it out there."

Distenfeld does admit that certain areas of the high yield market may be frothy, although not in bubble territory. He is especially worried about low quality, triple C-rated securities being too rich, as investors ignore a higher default risk while grasping for yield.

Defaults, however, have not been a problem in this latest era of easy money.

"It makes sense for people to wonder if they are overvalued by historical standards. But when you see a historically low 2% default rate, it does make sense," said Dan Roberts, portfolio manager for the MainStay Unconstrained Bond Fund (MASAX).

The other big worry in the sector is whether the quality of supply is starting to lessen as yield-starved investors continue to gobble up whatever supply Wall Street spits out out to meet their rabid demand. Michael Kirkpatrick, portfolio manager for the RidgeWorth High Yield Fund (SAMHX), said the record issuance is a concerning trend, but like Distenfeld, he only sees the problems popping up in the junkiest part of the market.

"When you dig beneath the numbers you see that a lot of it has been used for refinancing activity so it's not necessarily new net supply," says Kirkpatrick. "It's something we are monitoring but we don't see excesses just yet."

Not every bond fund manager is backing away from the "bubble" label, however. Tom Atteberry, portfolio manager for the FPA New Income Fund (FPNIX), disputes the claim that investors are getting paid appropriately for the risks they are absorbing.

"We would agree that there is a bond bubble. Five years ago the coupon on new issues would have been roughly 10% but now it's down to 6%. So the bondholder is playing an equity position in the capital structure but the coupon they are receiving is only around 6%. Shouldn't your returns be 8% or 10% if you are taking equity risk?" asked Atteberry.

-- Written by Gregg Greenberg in New York

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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