In a market overcome with interest-rate jitters, people are looking for investment vehicles that aren't as sensitive to rising rates. So why is everyone avoiding junk bonds and junk-bond funds like the plague?
Junk bonds, also known as high-yield bonds for the big interest payments they provide to attract investors to a company whose debt is below investment grade, typically are less vulnerable to interest-rate movements than higher-quality debt. But they've been dogs by just about every measurement.
And junk-bond funds reflect this. The average high-yield bond fund is off 2.21% since Jan. 1, compared with negative 0.4% for the average bond fund, according to
. Meanwhile, money has been flowing out of the fund sector for the entire year.
It's unlikely that the high-yield market will recover any time soon. Even though the stock markets are in turmoil, there's no indication that investors are warming up to bonds in general, and junk bonds in particular. Without those dollars, bonds can't fetch attractive prices in the market.
"For us to get to some floor, we need to see flows reverse and have some sort of sentiment change," says Ted Neild, a managing director at
Junk bonds and the funds that invest in them have a couple of big factors working against them. First, liquidity -- the ability of sellers to unload their bonds -- has all but evaporated. Investor disinterest combined with one of the highest default rates of the decade has resulted in plummeting prices, crimping fund returns. High-yield bond funds have seen money pour out at a greater pace than most categories at a time when stock fund performance has soared. In 1999, $609.9 million went into high-yield bond funds. But from Jan. 1 through May 3, $5.52 billion flowed out, according to data from Arcata, Calif.-based fund tracker
. (Note: Some fund groups haven't yet reported for April.)
High-yield bonds often move in tandem with stocks. They may be priced off other bonds, but the company fundamentals are the same as those used to evaluate equities. Some of the funds that invest in truly speculative stuff are down as much as the go-go tech funds that have stolen the spotlight in recent years.
Take the case of the
PaineWebber High-Yield fund, a taxable corporate-bond fund full of ailing Old Economy workhorses that's down 16.1% year to date. It's one of the worst-performing funds of the category, most likely the result of one or more individual bond blow-ups (though manager James Keegan couldn't be reached for comment). Wild gyrations like that are usually the province of Internet or biotech funds.
PaineWebber is hardly alone in the decline. "The market for high yield has been horrible," asserts Sarah Bush, bond analyst with
Other funds that are suffering concur: "Clearly the demand side is pretty low," says Vic Thompson, head of global fixed income with
State Street Global Advisers
in Boston. "It's hard to bring deals when nobody has money to spend." Thompson oversees the $38 million
State Street High-Yield Bond fund, which is down 0.11% in the year to date.
Though Thompson declined to discuss the fund's holdings, the latest report reveals that it's holding a significant amount of telecommunications bonds, which performed strongly last year but have fizzled amid the selloff.
"Managers are saying, 'The pricing services price this bond at X, but when I go to sell it, I can't get anywhere near that,' " says Bush. So sellers take what they can get and the price of the bonds drops from where they were purchased in the thinly traded market.
Also hurting the junk bond market is that defaults have grown dramatically.
, the bond rating shop, estimates that the rate of defaults for 1999 was 4.3%, not such a high percentage except for the fact that in the three years prior, the rate had hovered around 1.5%. In the past year, the market has been saddled with such high-profile defaults as satellite telephone system
Fruit of the Loom
But it's not just junk bonds that are suffering; investors have hardly been flocking to the asset class as of late. As a group, they pulled out more than $7 billion from all bond funds in the first three months of 2000. Over the last year, as the
started raising interest rates beginning last June, high-yield bonds were about the only corner of the bond market to duck because they aren't as sensitive to rising interest rates as higher-quality paper.
In addition, the telecommunications area heated up not only for stocks but also for the bonds they issue, giving some high-yield funds a noticeable pop. But a slumping technology market has hurt the funds holding those bonds. And retailing and manufacturing have seen some of the highest default rates, Fitch says.
"It really depended on what sector you were in," says Robert Grossman of Fitch.