The recent market rally and signs of green shoots in the economy has increased investors’ appetite for riskier asset classes.
Darrin Smith, portfolio manager of Morningstar 5-star-rated Principal High Yield Bond Fund (CPHYX), says high-yield bonds are an “opportunity to invest in fixed income, but receive equity-like return.” His fund currently is up 21.22 percent year-to-date.
“Technicals are very strong right now for high-yield bonds,” Smith said, adding that spreads are at a “happy medium right now at 1,000 basis points or 13 percent yield.”
Demographic trends and “good policy support from Washington” make health care and pharmaceuticals attractive, he said. He explained that the industries are very stable and are using their cash to deleverage.
Select Medical Corporation
Yield: 12.5 percent
Coupon Rate: 7.625 percent
Maturity Date: 02/01/2015
(Select Medical Corporation, which operates long-term acute care hospitals, is part of Smith's fund.)
Smith also likes Teck Cominco, a global mining and mineral processing company based in Vancouver. He said the company is a fallen angel that incurred financing concerns with an acquisition, but has been able to refinance its debt.
Yield: 10 percent
Coupon Rate: 10.75 percent
(Smith's fund holds Teck Cominco.)
He said that from a valuations perspective, Sprint Nextel’s wireless assets “have substantial value in excess of its debt.”
Yield: 12 percent
Coupon Rate: 7.375 percent
Maturity Date: 08/01/2015
(Smith has Sprint Nextel bonds in his portfolio as well.)
Steve Kane, generalist portfolio manager of the Morningstar 5-star rated Metropolitan West High Yield Bond fund (MWHYX), which is up 29.11 percent this year, said investors should be “wary of companies that levered up during the last cycle.”
There was significant leveraged buyout activity from 2005 to 2007, he said. As a result, the market is pricing in a 30 percent default rate on high-yield bonds “due to leverage and a tough economic environment.”
Jamie Farnham, director of credit research for Metropolitan West, said leveraged buyout companies used to have stable cash profiles, but cyclical industries during this market have experienced “constricted cash flows.”
Farnham invests in less cyclical industries such as utilities and health care. He said the economic recovery “may be prolonged and choppy,” but these industries will be more resilient.
Greg Hopper, portfolio manager of the Morningstar 5-star rated Artio Global High Income fund (JHYIX), which is up 27.57 percent this year, said high-yield bonds are a “diversifier and a legitimate asset class” and are “increasingly important to investors” for income generation.
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Disclosure information was not available for Kane, Farnham or Hopper. See above for information on Smith's fund holdings.