HIGH YIELD/JUNK BONDS
Securities rated BBB and above are called/rated investment grade. Securities
rated below investment grade are euphemistically called "junk bonds". These
securities carry a high degree of risk- primarily those at the lower end
of their individual rating scale (CCC)- are considered speculative investments
by the major credit rating agencies. The following are excerpts from Moody's
and S&P's definitions for speculative grade debt obligations.
Moody's- Ba rated bonds have "speculative elements", their future "cannot be considered assured", and protection of principal and interest is "moderate" and "not well safe guarded". B rated bonds "lack characteristics of a desirable investment" and the assurance of interest or principal payments "may be small". Caa rated bonds are "of poor standing" and "may be in default" or may have "elements of danger with respect to principal or interest".
Standard and Poor's- BB rated bonds have "less near term vulnerability to default" than B or CCC rated securities but face "major ongoing uncertainties.... which may lead to inadequate capacity" to pay interest or principal. B rated bonds have a "greater vulnerability to default" than BB rated bonds and the ability to pa interest or principal will likely be impaired by adverse business conditions. CCC rated bonds have a "currently identifiable vulnerability to default" and, without favorable business conditions, will be unable to repay interest and principal.
High yield bonds may be issued as a result of corporate restructuring, such as leveraged buyouts, mergers, acquisitions and debt recapitalization. These bonds are also issued by smaller, less credit worthy companies or by highly leveraged firms. They are generally less able than more mature larger firms to make scheduled payments or interest and principal.
Vanguard's High Yield Fund prospectus literature also notes that "credit quality in the high yield market can change suddenly and unexpectedly, and even recently issued credit ratings may not fully reflect the actual risks imposed by a particular high yield security."
Note: All commentary refers to high yield funds of acceptable diversification and monitored by a competent manager. Individuals of limited means (most middle income wage earners) should not buy individual issues under almost all circumstances. Non diversified portfolios contain risk in themselves- and the use of higher risk investments invariably pushes the risk limit too high and makes them unsuitable. Further, the term diversification takes on added dimension when used with lower grade corporates. Due to their thin markets (described below) and the grading of the bonds, some pundits suggest that the portfolio contain at least 75 to 100 issues. They also suggest that the portfolio be reviewed to determine if the bonds are the more actively traded.
Larger, more active issues do not fluctuate as greatly in value and are more liquid for redemptions.
But in regards to high yield mutual funds, does this mean that they should not be used by prudent investors? My position is that they can be effectively used by investors who understand the risks (which admittedly few could or would), can accept the risk as part of the entire portfolio (many could), have a diversified portfolio in total (debatable), and will closely monitor the economics and other impacting areas that would/may negatively impact fund value (the crux in the use of any risk portfolio and the reason why many should not even use these in funds. See risk retention vs. risk management elsewhere).
This list of concerns is extensive, as well it should be due to the potential volatility of the investment and the fact that significant losses can and have occurred. Further, the reason for the losses are not simply due to the factual issues of defaults, but primarily the esoteric political and emotional issues surrounding junk bonds. They are not well understood. Some of the concerns are discussed below.
Return
High yield instruments have returned about 350 - 450 basis points higher than T-bills from 1982 to 1988. That, factually, is quite a difference and the reason why they are considered by many seeking a higher return. Is the spread sufficient for the real (or perceived) risk? According to The Handbook of Fixed Income Securities, Chapter 45, High Yield Bond Portfolios, page 982, "the promised yield spread on high yield bonds has been far more than enough to compensate for the credit losses that have been experienced to date."
Total Returns (Handbook of Fixed Income Securities, pg. 986)
| Portfolio | 1988 | 1987 | 1986 | 1985 | 1984 | 1983 | 1982 | 1981 | 1980 |
| Salomon
High Yield |
15.20 | 4.46 | 16.50 | 23.60 | 8.60 | 21.90 | 30.802 | 3.40 | 0.40 |
| Drexel Composite | 14.50 | 6.40 | 19.30 | 22.50 | 8.50 | 19.70 | 32.50 | 2.70 | 0.90 |
| Shearson
Govt/Corp |
7.58 | 2.29 | 15.62 | 21.30 | 15.02 | 8.00 | 31.09 | 7.80 | 4.90 |
| Shearson T-Bond Index | 6.99 | 2.00 | 15.61 | 20.91 | 14.47 | 7.05 | 27.84 | 9.24 | 5.61 |
| Shearson Corp Bond Index | 9.22 | 2.56 | 16.53 | 24.06 | 16.62 | 9.27 | 39.21 | 2.95 | -0.29 |
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The figures above reflect accounts of all bond returns where there are no requirements for liquidity- the funds are not forced to liquidate due to redemptions. Mutual funds are impacted by this phenomena and must be addressed separately. Morningstar- an independent service that provides statistics and analyzes mutual funds- notes the following returns through 10/92.
High Yield annual composite bond fund return and comparison (+ -) to Lehman Brothers Govt/Corp index
| 10/92 | 1991 | 1990 | 1989 | 1988 | 1987 | |
| High Yield | 14.89 | 37.29 | -10.88 | -2.17 | 13.00 | 1.72 |
| Lehman index | 9.04 | 21.16 | -19.16 | -16.40 | 5.52 | -0.58 |
| 1986 | 1985 | 1984 | 1983 | 1982 | 1981 | 1980 | |
| High Yield | 12.88 | 21.94 | 8.18 | 16.04 | 30.79 | 6.02 | 3.58 |
| Lehman | -2.74 | 0.63 | -6.84 | 8.04 | -0.30 | -1.19 | .52 |
There are minor differences between the figures since different portfolios and indexes are utilized, but there appears to be a general trend in recent years for funds to underproduce the Salomon Bond Index. The difference might result from the requirement that a fund must liquidate assets when there are redemptions (mentioned below) thereby causing lower returns than portfolios that can maintain their integrity.
Default
The major controversy regarding junk bonds- but, I submit, NOT the real problem in use- is the perceived "high" default rate. But a review of these bonds from 1974 to 1984 shows that the default rate of all low rated debt instruments was only 1.5% per year. To put that number in perspective, the default rate for all debt from 1950 to 1989 was .15% per year. The default rate did escalate in 1986- 1988 and further studies show the default rate to be between 2.1% and 3.5%. Other studies have also shown that defaults and bankruptcies occur infrequently even among issuers of high yielding securities.
Volatility
Again per The Handbook of Fixed Income Securities, the author of the section, Howard Marks, CFA and portfolio manager, who handled millions of dollars of high yield instruments, noted that the standard deviation on his high yield portfolios (7.4%) was actually less than the Shearson Lehman Government bonds (high rated) (8.2%). This means that there was less volatility in final return than what an investor would have experienced on higher rated government bonds.
Liquidity
Based on the above, high yield funds can provide a return acceptable to risk- BUT only when utilized in managed accounts which are not required to sell any of the debt as demanded by investors for liquidity. And that need identifies an area of risk not in the norm of portfolio use. It is the emotional/perceived risk in 1.) not understanding how the debt instruments may be efficiently used in a portfolio and 2.) recognizing that even if structured properly, there are too many esoteric problems that cause volatility of a fund irrespective of the debt itself. And it primarily has to do with the "illiquidity" of a liquid fund.
1. The real problem with high yield funds is simply that mutual funds guarantee a market for their shares and must pay out on a sale within seven days of the redemption. Unfortunately, and due to the emotional concerns on these bonds, investors are apt- and do- react to any perceived problem and request, I submit, unnecessary and large redemptions.
Market timers are an "excellent" source for these movements and many have caused havoc with a number of the 47 current funds. For example, in October/November, 1992, market timers pulled out more than $2 billion- about 6% of the total invested on September 30th in high yield bond funds. This landslide caused further investor redemptions with the result of a net loss of 1.59% for that month alone. Other concerns include legislative and regulatory changes that can change the tax status of interest or corporate restructuring. Regardless of the cause, excessive redemptions are a major concern. Some fund managers- mostly no load- are therefore considering instituting back end loads for investors who have not held an account for, say, at least 12 months.
1. Part of that loss is caused by the fact that the bond market in general- and the high yield market in particular- are not as large as the stock market exchanges nor as efficiently traded. Hence the thinly traded high yield bonds, which must be sold quickly for redemptions, might not find a quick market for their true or "appraised" value. The number of bonds in the marketplace is, unfortunately, not evidence of a stronger or more liquid market. In the first 10 months of 1992, the SEC has shown that number of new issues was $34 billion- more than in all of 1986 which was the prior peak for new issues. And $7 billion more was waiting to come to market. But the problem really is that 62% of the new issues were rated B or lower compared with 435 a year earlier. If the Clinton economy doesn't hold up, a number of funds cold be hurt since the runs on the bank will become more frequent and of larger magnitude.
It is important to note that most other bond funds- and some small cap stock funds- are in exactly the same position with thin markets, but that market timers are not as great a concern. But high yield funds are not well understood and therefore suffer greater exposure and risk to emotional plays in the market. The point is however, that understood or not understood, the mere fact that outside influences are negatively impacting the funds must be addressed by the investor.
2. Even when a fund might be using a higher (most conservative- BB) grade of high bonds that are more widely used, the funds are usually/may be forced to sell those first when there is a "run on the bank". They might suffer even greater losses than those funds holding debt of lower grade (Vanguard's position in October/November 1992). Even should an fund recognize this exposure and leave a greater amount in cash or government securities for the liquidity, investors must realize that while the loss of principal is reduced, so is their current yield since these instruments pay lower returns.
Summary
Overall however, the use of better graded high yield corporates is definitely worthwhile. A study by First Boston showed that from 1/86 to 11/92, the better graded bonds provided a 27% greater return than the junk bond market as a whole with 42% less risk. Lower grade bond funds might do better in some short term time frames (lower rates, an upgrading of bond ratings), there simply is too much risk for almost all investors. It is therefore necessary that they carefully review the portfolios makeup and history.
If the risk has been properly identified and accepted, high yield funds can outproduce other bond indexes on an ongoing basis. They cannot be dismissed as an investment- if for no other reason than they currently account for over 21% of all debt (up from 3.5% in 1977). However their volatility- due to either real or perceived concerns- the fact that they have a limited history/track record on which the entire analysis is based and that governmental policies can radically alter their use (as was evident when banks were forced to reduce their exposure on junk bonds in 1988)- leaves one with the conclusion that they would appear to be acceptable only to accounts actively managed. Risk retention (non management) of these instruments seems to be too excessive for most middle America. Recent articles have agreed indicating that investors should hold their exposure to as little as 10% of their entire portfolio since they feel that an investor cold lose up to 10% of a portfolio's value over a period of just a few months. While I think that the 10% might be slightly too conservative, even those willing to take a substantial risk should probably limit their non managed exposure to no greater than 20%. Again, it would be necessary to define the investment time frame for the investor, their age, etc. Excessive use is unsuitable.
Morningstar Weighted averages of high yield bond funds 11/92
Average Maturity 8 year
Weighted Coupon 11.36%
Weighted Price 98.28
Cash 4.6%
Stock 1.8%
Bonds 89.5%
Preferreds 2.0%
Convertibles 1.8%
B rated 60.0%
HIGH YIELD FUNDS: (SF Chronicle 10/1993) the following junk bond funds vary considerably in return- but that is due primarily by the risk of the bonds they buy.
| Fund Name | Yield | 1 year return | 3 year return |
| Fidelity Capital | 6.45% | 21.04% | 22.34% |
| T Rowe Price High Yield | 9.11 | 17.99 | 15.40 |
| Vanguard High Yield 9.15 | 16.30 | 14.72 | |
| Financial Bond High Yield | 8.29 | 16.46 | 13.75 |
Fidelity takes the highest risk by investing in the lowest grade bonds that are actually in default or bankruptcy. Because they are not making payments, that is why their yield is lower. By the same token, if they do come out of bankruptcy, their value goes up tremendously- hence the high returns. T Rowe Price and Vanguard are far more conservative in the bonds purchased. Vanguard has the highest overall ratings of bonds in their portfolio. It also has about 10% in treasuries and it never touches the zero coupon bonds or payment in kind issues. If the market rallies, it is NOT first in its field- by the same token, it did not suffer as great a loss in 1989 and 1990. Financial Bond invests in larger amounts in fewer issues where there is supposedly less credit risk. It does not believe that greater diversification works with junk bonds. Personally I have some problem with that statement since, at least statistically, diversification of 10 to 15 issues is needed with most securities.
JUNK BONDS (1994) : Kiplinger's had an article about junk bonds (those with bond ratings under BBB. Bonds rated BBB and above are called investment grade- never forget that terminology.) and noted that Northeast and Fidelity had the top performing funds for the last year and five years. I guarantee people would be inclined to use these because of that article- but only if they were stupid. (Yes I DO realize that I'm being very critical here, but I need to make a point!) Investors must know why these funds got the highest return. Do you know? It's because they have some of the lowest rated bonds in their portfolio. (In November, Northeast overall credit rating was CCC and Fidelity had three junk bond funds rated CCC-, CC and C.) The lowest rated bonds invariably pay the highest interest and, potentially, have the opportunity for appreciation if interest rates and the economy mover in the right direction. Now that may be fine, but the risk is significantly greater than a junk bond fund that has much better quality. And what if the economy goes the wrong way? What then? That said, I actually use "junk bond" funds and have done so for years. But I am unwilling to take a huge risk in this area and therefore have opted for the best ratings in this category. So what fund has one the highest average rating in this category? Vanguard (BB). Is it number 1 in return? No! But how much extra risk are you willing to take? All the above commentary means that investors must go the extra mile in analyzing an investment and not select one solely from an article from a newspaper writer who probably has little analytical competence. To do so is to miss the salient features of the investment and investing.
MORE JUNK BONDS: Here are some interesting fundamental overviews on junk bond portfolios and risk from Financial World. First, we all know that as interest rates rise in the economy, bond prices will fall- and vice versus. But rates may have a lesser impact on junk bonds because these bonds also react to the changing fortunes of the companies they represent. As rates rise, investors will investigate the risk of that company being able to make the higher interest payments on the debt. Of course, if the investigation shows the company is less able to meet the new conditions, the bonds could drop double fold. But in an expanding economy- one that we have had (albeit some would say otherwise)- credit risk and interest rate risk may offset each other since, if the economy is improving, so could the prospects of the companies rating (meaning it's getting better) and the price changes could offset each other. Therefore, numerous studies have shown that a junk bond's low credit quality actually lessens the overall risk of junk bond mutual fund portfolios. Again, however, I am only willing to expose myself so far. Hence my option for the better grade junk bond versus an overall C rated portfolio.
AND MORE JUNK BONDS: There is also the concern about defaults of low rated companies. About five years ago, there was about a 10% rate of default- primarily due to the fact that S&L's- large and long time holders of junk bonds- were forced by government regulators to sell them at the worst possible time. However, a study by New York University shows that the default rate in the first nine months of 1994 was a minuscule 0.55%. The historical norm is 4.1%. Also recognize that if a bond defaults, you don't necessarily lose altogether. Investors average about 40 cents on the dollar for a defaulted bond. Why? Because other investors believe that many of these companies may make their way back and give them substantial appreciation on the bond prices.
JUNK BONDS: (5/95) Junk bonds by themselves are conspired risky investments. So why do I use them? Because if you understand the risks, they are not all that bad. Secondly, if used in context with other investments, they (as well as other investments) can actually reduce risk. How is that possible? Well, let's consider statistics for the stock market. From January 1988 to March 1994, the standard deviation (volatility) was 3.6% per month. For a portfolio made up of 70% stocks and 40% bonds, the standard deviation dropped to 2.8% (random/negative correlation- they don't move the same way for the same reason at the same time).
But with 60% stocks, 20% high grade bonds and 20% high yield bonds, the standard deviation dropped further to 2.6%. Correlation between high yields and government bonds is only 0.2. With investment grade bonds, it is slightly higher at 0.4.
Over the past five years, corporate high yield funds have returned 12.70% versus 7.85% for corporate bonds and 7.47% for government bonds. Obviously there are several issues to address when using these, but I have done so for close to ten years and think that they can be a viable part of most portfolios.
JUNK BONDS: 3/96 I have commented on these some time in the past, but they bear review due to their resurgence from the problems in 1990. The investments in junk bonds rose from $43 billion at the end of 1994 to $53 billion by the end of 1995- due in part to the lowering of interest rates. As of 12/31/95, the yield on junk bonds was about 9.25% versus 5.8% in the average treasury fund and 5.95% for the average corporate bond fund. Of course, that yield makes many unsophisticated investors drool and opt for the higher risk. Is it a suckers bet? I think not as long as proper asset allocation is addressed and you understand how the bonds fluctuate in value as compared to other bond funds. First of all, with higher yields to begin with, junk bonds don't fall as much as Treasury instruments do when interest rates rise (you also need to consider the maturities of the bonds). In 1994, when Greenspan raised rates, 10 year Treasuries dropped to a negative 8.3% return while high yield junk bonds dropped to only a 1.17% loss (your fund may vary from these statistics). But the scenario for junk bonds is made difficult since interest rates are not the only issue to consider. The major "culprit" shall we say, is the strength of the underlying economy since the company offering junk bonds is more akin to do well in a prospering economy and do poorly in a flat or declining economy. Consider a company that has a C rating. If the economy booms, the company (many times a small and growing concern) probably does better and its balance sheet improves. It's bond rating might increase to a B. So now a client has a high yield AND a better rating. But in a declining market, less income could portend lower ratings and thereby increase the risk. Now you could even have the problem of getting payments on the bond.
These funds are therefore more akin to small cap stock funds and perhaps should be allocated the same as far as risk is concerned. Also, previous studies have shown that the default rate on these bonds have been relatively low (many investors think otherwise) and any defaults have usually been offset by the higher yields. Nonetheless, buying individual high yield bonds is for the experts. I definitely suggest mutual funds and those that use companies with relatively strong ratings. Yes, you can get more return by using very low rated companies, but I think the risk is just too great.
In summary, high yield bonds have provided consistently good returns with relatively acceptable risk. However, the huge increase in the market may make them vulnerable if the stock market tanks since they are closely tied to stocks. One saving grace is the fact that inflation and interest rates are projected to stay low. Nonetheless, high yield/junk bonds can still only be just a portion of an entire portfolio.
HIGH YIELD BONDS: (FED Board of NY 1996) The use of "junk bonds" has grown almost exponentially from $30 billion in 1980 to $250 billion in early 1996. The default rate seemed to be relatively mild as I reviewed other reports, but the FED noted that in the mild recession of 1990-91, it soared to 11%. That sure puts a different focus on what I may have to do in the next downturn since they seem to be far more volatile recently than what I had anticipated.
HIGH YIELD BONDS: (1997) The FED noted that the average default rate was just under 4.5% but ranged from the high of 11% in 1991 to under 2% in 1981 and 1994. Three reasons were supplied for the variations. First, the changes in credit quality of speculative grade bonds is affected over time. Even if there is just a fraction of lower rated bonds, the aggregate default rate should rise.
Second, the state of the economy affects the rate as well. As rates rise, a company is strapped to make payments. Or if business slows, there's no money for payments either.
Thirdly, and a fact that I had not previously seen: most defaults are most likely to occur within three years after being issued. It means that the length of time the risky bonds are outstanding will affect the default rate. Part of that equation may simply be that these types of bonds are offered most often when times are good. Given a three year later period, the economy may simply have changed to a different cycle and therefore the companies are directly impacted.
The study concluded by saying that credit quality is the most definite criteria regarding default. Further, that an economic downturn shows a tendency for higher risk bonds to default (logical).
HIGH YIELD BONDS (1997): Normally called junk bonds, I have used them for years with many clients. The high yield insulates them somewhat from the movement of interest rates overall and historical guidelines have shown that their default rate has been relatively low. Well, Business Week recently ran an article that showed that the risks involved with these bonds has even been less than Treasuries. The standard deviation of junk bonds- a reflection of volatility- has been only 5.14% over the last five years and had an average return of 13.5%. Thirty year Treasuries had a 9.32% standard deviation and an overall 10.5% return. The Lehman Brothers Index returned 9.32% with a deviation of 6.32%. But much has to do with a solid economy and where small businesses have prospered. Don't go out and buy lots of these thinking that they can maintain this return without being aware that, sometime in the future, rates and the economy will absolutely change and company bankruptcies and bond defaults will increase. The BW advisers suggested only 3% to 5% of a portfolio should use high yield bonds. Perhaps O.K. if left unmonitored. Otherwise up to 10% to 15% may be utilized but you have go to know what you are doing.
1998 There are numerous statistics on the default rate of bonds rated less than Investment Grade (BBB). Regardless, this puts come numbers in perspective. Due to low inflation and the great stock growth, these lower rated companies have seen their bond ratings rise- hence lower defaults. During the 12 months ending June 30, 1997, the default rate was just 1.5% versus the 6.8% in 1992. But don't be misled. When the economy changes, those companies with the lowest ratings WILL default- or at least get even lower ratings- and holders of those lower rated junk bond funds will lose big time. Notice I said lower rated- some "junk bond" funds have an overall BB rating and these should be O.K.
HIGH YIELD BONDS AND TREASURY INSTRUMENTS: (NY Times 2000) In June, 1999, 10-year Treasuries were yielding 5.35 percent, while an index of high-yield bonds averaged 9.11 percent -- a spread of 3.76 percentage points. On October 8, 1999, the spread had widened by nearly a full percentage point, to 4.67, with the high-yield index averaging 10.7 percent, compared with 6.03 percent on 10-year Treasuries. Why? Because even though the FED has not raised rates that much- or even at all at the last meeting- funds have nonetheless dried up for all but the best of companies. The higher potential risk transfers into higher yields. In fact, the "default rate on junk bonds is climbing and is now running ahead of last year's rate." So, is the stock market taking note? Not really- the euphoria continues. But I would bet the house that Greenspan and the FED will raise rates not only at their next February meeting but at other times during this year.
High Yield Bond Defaults: (Edward Altman, NY Times 2000 ) From 1996 to 1999 "you had a huge number of low-quality issues coming to market." As proof, defaults showed up within a year or two of the financings, instead of the more typical three or four years. Altman found not only that the default rate on bonds jumped to 1.58 percent in the second quarter, from 1 percent in the first quarter, but also that so-called distressed debt had reached "somewhat ominous" levels.
Nonetheless, the cumulative total of defaulted and distressed debt, estimated at 23 percent of the amount outstanding at midyear, remains far below the 43 percent in 1992.
Moody's Investors Service calculates that 6.2 percent of high-yield, or junk, bonds are now in default. It projects that the rate will rise to 7.1 percent by year-end, and to 8.4 percent by July 2001.
Why the problem? Essentially, banks lowered their credit quality in the fast growing early and mid 1990's. Now with tighter interest rates and caution by the FED to banks to watch their loans, companies are not easily able to refinance. And some companies were in trouble anyway. You can still use junk bonds- say 10% of a portfolio. But I have always used those funds that use higher rated junk bonds. Check out Vanguard for instance.
High Yield Bond: (S & P/Portfolio Management Data 2000) Banks and other companies are increasingly wary of lending to start-up businesses, companies undertaking leveraged buyouts and other leveraged enterprises. The volume of new loans to such companies, which typically carry bond ratings below investment grade, was 25 percent lower in the first nine months of this year than it was in the corresponding period a year earlier
(Donaldson, Lufkin & Jenrette)- For the 12- month period ending on Aug. 31, 3.87 percent of all high-yield debt was in default, up from 1 percent two years ago.
Junk Bonds: (NY Times 2001) the default rate is now about 8%. American Express bought a bunch of these as collateralized debt obligations and are getting hammered for about a $826 loss. The chairman noted, American Express "did not fully comprehend the risk".
That lack of knowledge is a function of the strides that have been made in financial engineering. Derivatives make it possible to shift risks in ways that were undreamed of even a decade ago. But the computer models used to figure out how to value those risks are sometimes not very good. American Express says it will not take such risks again, although it will keep manufacturing such derivative securities to be sold to its institutional clients. (Would you patronize a chef who won't eat his own cooking?)"
In the late 1980's Merrill Lynch also lost a bundle with these CMO's. Like anything else, they can work fine in a relatively stable economy and stock market. But the computer generations cannot consider that the market is not sophisticated- it swings by investor emotions. Look at what happen to tech- it never should have gotten that high. But because it did through the neverending process of people throwing their money away, the down reaction to our economy has ben much more severe than it should have been.
Junk Bonds (NY Times 2001) More than $64 billion worth of new high-yield bonds were sold in the first half of the year. That is more than all the junk bonds sold in 2000. Default rates have been rising since 1997, and rate spreads versus Treasuries have been widening since 1997 and 1998, at the time of the Asian crisis. The default rate is probably peaking now. If the economy really does turn around, then default rates are going to come down and price performance of the bonds ought to be pretty good.
Junk bonds- (2002) According to Merrill Lynch & Co. data, the spread of junk bonds to Treasurys is over 10.6 percentage points, the biggest gap since the company began tracking the relationship in 1986. The gap stood near 6 percentage points about six months ago.
The previous record was a 10.5 percentage point gap reached in January 1991, a period of recession for a nation on the brink of an attack on Iraq.
This asset class has lost 10 percent on a total return basis so far this year
Not quite yet- but soon: (USA Today 2002) The average junk-bond fund has lost 10% the past five years, a record even more abysmal than the Standard & Poor's 500-stock index, up 5%, and the average money market mutual fund, up 22%. The average junk-bond fund has a 12-month yield of 10.6%. Default rates have soared to 9% from 2.4% five years ago. They peaked in February at 11.4%, the highest level since the 1991 recession. Of the estimated $100 billion in junk bonds sold in the three years ended 1999, about 40% have defaulted. Most of the companies that have defaulted recently were in the telecommunications industry. The average bond that matures in seven to 10 years yields about 12%, or about 8 percentage points more than 10-year Treasury notes. That's up from 5.5 percentage points a year ago and close to record levels.
Junk Bonds (NY Times 2003) The default record set in 2002 was a little more than six percentage points higher than the 8.8 percent default rate in 1991, at the depths of the last recession.
Junk Bonds: (NY Times) A way of measuring rising attractiveness of junk bonds is the narrowing of the spread, or difference, between the yield on these non-investment-grade bonds and the yield on comparable Treasury securities.
The spread has plunged to 5.21 percentage points at the end of last week, down from 8.48 percentage points in September, which was close to a 12-year high.
Junk: (2003) JUNK'S TIME IN THE SUN
Avg. High-Yield Fund Return High-Yield Fund In-Flows ($bill.)
YTD 15% $13.4
2002 -1.8 7.5
2001 2.1 6.1
2000 -7.3 -13.4
1999 4.5 -2.3
High Yield bonds: (2003) Investors have already plowed a record-breaking $23 billion into junk bond mutual funds so far this year, according to fund trackers AMG Data Services, while investment bankers meanwhile reckon they can sell upwards of $100 billion worth of speculative grade paper in 2003.
The last time junk bonds did that kind of business was the late 1990s when issuance hit a record $139.9 billion in 1998 -- just as the risk-free, technology-based, new economic miracle was getting into full swing.
U.S. junk bond mutual funds suffered $91 million in outflows in the week ended July 23, their third week of outflows in the last five, according to research firm AMG Data Services. Junk bond funds took in $1.2 billion the previous week and saw a record $23 billion of inflows this year. Bond analysts have warned that junk bonds are too richly priced after a sharp rally this year, turning some investors cautious on the market, however. For the year, junk bonds posted total returns of 18 percent, according to Merrill Lynch, beating all other kinds of U.S. bonds, although the market's gains have slowed in recent weeks. The latest junk fund outflows came as investors cashed out of various bond funds and poured money into stock mutual funds. Investment-grade corporate bonds lost $388 million, while mortgage-backed bonds saw $132 million in outflows. Stock mutual funds took in $3.2 billion
Junk bonds: (2004) The global junk bond default rate fell to 4.54% in January from a revised 4.71% in December, and should continue to fall courtesy of favorable financing conditions and an improving economic outlook, according to Standard & Poor's. January's global default rate was its lowest since May 1999, while the junk bond default rate of 5.39% in the US during the month was the lowest since December 1999.
The US high yield default rate ended 2003 at 5%, a level less than one third 2002's extraordinary 16.4% rate, according to Fitch Ratings. Default volume fell 69.2% compared with 2002, and the number of companies defaulting on their bond obligations fell 39%. The cumulative default rate over the period 1989 - 1992 was approximately 23%, while the comparable statistic for 2000 - 2003 was 9.4%..
But as the default rate drops, so will the interest rates. But as the companies get stronger, the value should rise more than offsetting the reduced yield.