Junk Bonds Ride Coattails of Cyclicals' Recovery

The high-yield bond market has rebounded from last summer's meltdown.
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This is junk?

Fidelity's

two junk-bond funds,

(SPHIX) - Get Report

High Income and

(FAGIX) - Get Report

Capital & Income, have been outperforming the stock market this year. High Income was up 10.0% and Capital & Income was up 12.1% through last Thursday, according to

Lipper

. That compares with a gain of 9.4% for the

S&P 500

.

Much maligned, the junk-bond market has nevertheless been turning in some solid performance numbers, riding the same boom that has propelled cyclical stocks as of late. The plus: The junk-bond market, less sensitive to an interest-rate tightening, offers a better downside hedge than cyclicals.

"If the economy stays strong and grows, junk bonds are an excellent corollary to what people are doing on cyclicals right now," says James Lowell, editor of

Fidelity Investor

, a newsletter.

Since the start of the year, high-yield funds have blown the doors off every other fixed-income category, returning 5.5%, twice the return of any of Lipper's other bond-fund indices. The numbers mark a significant rebound from the panic that gripped the junk-bond market last August in the wake of the meltdown in the Russian economy. The Lipper high-yield index is up a tiny 0.6% for one year, thanks to last summer's massacre.

"The liquidity in the high-yield market is better, but not back to normal," says Daniel Fuss, who manages $13.5 billion in fixed-income money for

Loomis Sayles

, including the

(LSBRX) - Get Report

Loomis Sayles Bond fund. "But certainly it is not to a level we had a year ago."

Compared with stocks, bonds are a pretty vanilla world, where beating the market is often a matter of who has the lowest expenses. Junk bonds may be the only area in the bond market where active management is worth the fee.

"It is a very inefficent market," says Eric Jacobson,

Morningstar's

fixed-income editor.

Take Fidelity, for instance.

The world's largest mutual fund company has 16 analysts on its high-yield team, one of the biggest in the industry. The results: Among the 50 largest high-yield funds, none have done better than the High Income and Capital & Income funds year to date, or over the last one- or three-year periods. High Income, which carries Morningstar's highest rating of five stars, is No. 1 among all high-yield funds tracked by Lipper over the last five years.

Take the funds apart, and here's what you'll find: Just as the same names tend to appear in so many of Fidelity's hot-performing big-cap equity funds, the company's two junk-bond funds tend to have a lot in common too.

Both funds are overweighted in the cable, telecommunications and supermarket industries. Both have major positions

Supermarket General Holdings

(SUGHP)

,

EchoStar

(DISH) - Get Report

,

Amazon.com

(AMZN) - Get Report

and a number of other fixed-income securities.

Capital & Income, which has a four-star Morningstar rating, also has the ability to invest in equities, usually of companies fund manager David Clancy knows well because he also holds the debt. "The equities that I have owned have contributed enormously to the fund's performance -- even though they've never been more than 5% of the portfolio," Clancy says in an interview with Lowell's

Fidelity Investor

.

Despite the recent gains, Clancy thinks junk bonds still have room to run. "Junk sticks out as being cheap," he says. "There's obviously a lot of company-specific risk in all of these names, and you need to get your companies right. But relative to the other asset classes, I think that junk is cheap. Not as cheap as it was in August, but still cheap."

Fuss, whose Loomis Sayles Bond fund has about one-third of its assets in high-yield debt, is more cautious. He says the bottoming out of commodity prices could help some industries like oil and gas, but he worries about the debt of many other businesses, particularly suppliers. Says Fuss: "Pricing in high yield often is a guessing game."

Steven Syre & Steve Bailey write for the Boston Globe. This column is exclusive to TheStreet.com. At the time of publication, they held no positions in the stocks or funds discussed in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy stocks or funds.