High-yield 'junk bonds' are sounder than they sound
Some people call them ''high-yield debt issues.'' Others refer to them as ''high-income bonds.'' While these terms may be more accurate, the investment is more affectionately known as a ''junk bond.''
Even with a name like that, these corporate debt instruments are becoming increasingly popular, as investors look for ways to keep high yields in their portfolios. They are also more popular with institutional investors. Some of the issuing companies were once struggling, but they are now beginning to rise out of their recession-induced troubles and need additional sources of capital to grow.
The growing interest in these bonds, however, has some professionals concerned that individuals, in their rush from quality to yield, may not do the research needed to pick out the ''good junk'' from the ''real junk.''
Although there is no precise definition of what constitutes a junk bond, it is generally considered to fall in the B range, that is, bonds that are rated ''Baa'' or lower by Moody's Investors Service, or ''BBB'' and below by Standard & Poor's. The term also includes bonds that carry no rating.
Even investors who make a living looking for these lower-rated bonds seldom go below the three-B ratings into the C range. But there are exceptions, says William H. Pike, portfolio manager of Fidelity's High Income Fund, a mutual fund that specializes in higher-yielding debt issues. It is currently yielding around 12 percent. Sometimes, he says, a company has had trouble meeting its debt payments and thus had its bond rating reduced. But new bond ratings often do not come until well after a company has begun to turn around and show signs of strength.
One such company is Tiger International, the airfreight carrier. ''Our credit people looked into it, and it doesn't look so bad,'' Mr. Pike noted. ''As the recession winds down and people ship more, Tiger should pick up additional business.''
Because individuals do not have full-time ''credit people'' and portfolio managers at their personal disposal, Mr. Pike reasons, they are probably better off in a mutual fund specializing in these bonds, where they have diversification of investments and many other investors are sharing the risk.
''In a portfolio of 100 bonds, you might have one bankruptcy,'' he adds. But the gains that can be made on the 99 others are more than enough to offset the one loss.
''Funds are a good way to buy these bonds,'' agrees Alvan Markle, first vice-president and director of fixed-income research at Butcher & Singer, a Philadelphia brokerage. ''At least you get a professional manager and diversification.''
Other financial advisers warn investors in these funds to keep a close watch on them. If interest rates continue to drop, the fund may shift its portfolio into increasingly risky investments, both to keep up yields and to have a place to invest new investor capital. One way an investor can be more careful is to use a fund that only buys bonds rated Ba (Moody's) or BB (Standard & Poor's) and above. The fund may allow a few exceptions to this rule, but sticking close to it reduces the temptation to overreach for high yield.
If there is ever a good time to buy junk bonds, Mr. Markle thinks this may be it. ''With the economy beginning to get out of its readjustment phase on its fourth try, this is logically the time you do look into lower-quality bonds.
''If business continues to improve, junk bonds have the most room to come back.''
Many junk bonds are paying 12 to 15 percent interest, not far from the yields that once came from the money market funds, which is one reason more individual investors are getting interested in the bonds, Mr. Pike believes.
''People got used to those high yields,'' he says. ''They want to do better than the 8 percent many of the money funds are paying now.''
It is not just individuals that are keeping up the demand for these bonds. Many insurance companies have policies with guaranteed income levels and need investment vehicles that will help them maintain those yields. An insurance company managing a corporate-sponsored pension plan, for instance, may have announced in January that the plan would pay 12 percent interest for the rest of 1983. Carefully selected lower-grade bonds are one way to help meet that goal.
And, with insurance companies on the prowl for these debt instruments, investment bankers, who once put most of their effort into underwriting strictly high-grade issues, are getting into the junk bond game. Joining them are a number of brokerages that can help individual investors find promising junk bonds. Besides Butcher & Singer, others that have been active in this area are Merrill Lynch, Bear, Stearns, Shearson/American Express, and E. F. Hutton.
The largest of the brokers dealing in high-yield debt, however, is probably Drexel Burnham Lambert Inc., which has 23 brokers selling the securities.
While these professionals are busy looking for the diamonds in the low-rated rough, they are also watching for bonds carrying no rating at all. Supposedly, these also fall into the junk bond category. Sometimes, for a variety of reasons , a corporation will issue bonds without getting a rating from Moody's or Standard & Poor's, even though the company may be as financially strong as an AAA-rated firm.
There are cases, however, where a bond-rating firm has simply refused to grant a rating. In this case, the investor should do even more research before investing in the bonds.
How Moody's and Standard & Poor's rate bonds Moody's S&P Aaa AAA High-grade bonds, considered Aa AA very safe. A A Medium grade. Baa BBB Ba BB Lower grade -- containing B B some degree of speculation as to eventual payment of future interest and principal repay- ment obligations. Caa CCC Highly speculative as to pay- Ca CC ment of interest and principal. C C Lowest ratings include bonds already in default. Source: "Why Stocks Go Up (and Down), A Guide to Sound Investing," by William H. Pike, Homewood, Ill.: Dow Jones-Irwin. $19.95.