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Junk Bonds Could Rally in Sluggish Economy

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

PORTSMOUTH, N.H. (TheStreet) -- Mary Austin, manager of the Pax World High Yield Bond Fund (PAXHX) - Get Pax High Yield Bond Inv Report, 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


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, 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.

Welcome to


Fund Manager Five Spot, where America's top mutual fund managers share their investment views in five fast and furious questions.

What can you expect from junk bonds in 2010?


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

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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.

What is your favorite high-yield sector?

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In this economic environment of slow recovery and slow growth, we have added to some of the cyclical sectors, including tech, paper and packaging, and media. They're sectors we believe should benefit from a recovery. We continue to like telecom as a defensive sector that could benefit from anticipated industry consolidation.

What is your favorite junk bond issue?


One of our favorite high-yield bond issuers is


, one of the five largest orthopedic medical device companies in the world. Approximately 75% of its business is the manufacturing and marketing of reconstructive devices including hip, knee and joint replacements, businesses that have performed well during the recent recession. We believe Biomet is somewhat immune to health care reform as it sells to health care providers that are reimbursed by third-party payers. Although its leverage is high compared to other bonds in the fund -- more than 6 times -- it has been gradually delivering since its leveraged buyout in September 2007 due to its strong free cash flow.

Name another one of your favorite high-yield bonds.


Another one of our current favorite high-yield bond issuers is


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, a leading ATM operator with over 37,000 ATMs located in the United States, U.K. and Mexico. In November,


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upgraded the company to Caa1 from B3 with a positive outlook. Cardtronics has demonstrated strong EBITDA growth and free cash flow generation that stands roughly at 9.4% of debt. Cardtronics also seeks to benefit from companies like


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, which are now paying some employees with cards that are used at ATMs to withdraw cash.

Which high-yield sector would you avoid?


Our current least favorite sector is leisure due to the high unemployment rate and uncertainty about the sustainability of consumer spending.


Reported by Gregg Greenberg in New York


Before joining, Gregg Greenberg was a writer and segment producer for CNBC's Closing Bell. He previously worked at FleetBoston and Lehman Brothers in their Private Client Services divisions, covering high net-worth individuals and midsize hedge funds. Greenberg attended New York University's School of Business and Economic Reporting. He also has an M.B.A. from Cornell University's Johnson School of Business, and a B.A. in history from Amherst College.