Junk bonds -- even in telecom -- may offer hope
FRIDAY, JULY 20, 2001 3:49 PM
- Reuters
By Jonathan Stempel
NEW YORK, July 20 (Reuters) - It's no secret the collapsed telecommunications sector has punished junk bond investors who thought diversifying was the way to invest in the risky bonds.
The question now becomes: Is the time now right to buy junk bonds, and if so, is avoiding telecom still the way to play?
Also called high-yield bonds, junk bonds are corporate IOUs that carry high yields because of their low credit ratings.
After posting near zero total returns between 1998 and 2000, the bonds' yields soared, typically to above 14 percent, a level experts considered absurdly high.
This year was supposed to be one when the bonds would provide investors total returns in the mid- to high-teens.
It's not happening. Telecom blow-ups have decimated many managers' returns, and turned junk bonds -- again -- into one of the worst-performing U.S. fixed-income classes.
"A lot of bad news has been priced into the market," said Scott Berry, an analyst for fund information service Morningstar Inc. "You can look at the yields on some funds and realize how discounted some of the bonds really are."
SLIDING RETURNS
Junk bonds have returned 3.4 percent this year, down from 8.45 percent in early March, according to Merrill Lynch & Co.
Junk bond mutual funds have done worse, returning 0.87 percent, according to Morningstar. Bank accounts do better.
Merrill Lynch said the bonds yield 8.17 percentage points more than safe U.S. Treasuries, which yield about 5 percent.
Meanwhile, Moody's Investors Service said the junk bond default rate is 8.1 percent, and will hit 10.1 percent by early 2002, the highest since the 13.1 percent peak a decade ago.
The key to performing well in 2001 has been to avoid ambitious telecoms that assumed they could raise huge sums to finance expansion, only to find the capital markets clam up.
PSINet Inc., Winstar Communications Inc. and a slew of others went bankrupt. Better-regarded companies, such as Level 3 Communications Inc. (NASDAQ NM:LVLT) and Williams Communications Group Inc.(NYSE:WCG), have bonds trading at levels that suggest default is more likely than recovery.
The result: The telecom portion of Merrill Lynch's junk bond index has sunk 22.18 percent this year.
So are telecom bonds still a bad bet? Experts are divided.
Kent Gasaway has avoided the bonds, and his $55 million Buffalo High-Yield Fund is up 12.13 percent this year, posting the second best return among junk funds Morningstar tracks.
"When you manage a high-yield fund with a lot of bankruptcies, it consumes your time, it consumes your life," he said. "It prevents you from going out and looking at new ideas. You're spending 80 percent of your time with lawyers."
Gasaway said investors should watch telecom stocks because they are a leading indicator for telecom bonds. The stocks are in sad shape, he said, making it too soon to buy the bonds.
In contrast, Berry said investors should consider diversified funds with telecom bonds. "Funds such as Northeast Investors, which own no telecom at all, have done very well, but could underperform as the market recovers," he said.
RAYS OF LIGHT
There are other signs junk bonds overall may soon improve.
Moody's ratio of rating downgrades to upgrades was 3.3-to-1 last quarter, but that's down from 4.2-to-1 last fall.
According to Merrill Lynch, "distressed debt," which yields at least 10 percentage points more than Treasuries, is consuming less of the market.
And when this year's six Federal Reserve interest rate cuts start to kick-start the economy, that would also help junk. Even, perhaps, junk telecoms.
"If you feel the economy is getting better and liquidity will return to the market, some of your better returns will be in sectors that ... have provided the worst relative returns," said Kingman Penniman, president of high-yield research firm KDP Investment Advisors Inc. in Montpelier, Vermont.
That, he said, could mean portfolio managers who avoided telecom bonds may turn "proactive" and see value there.
Of course, finding those managers now may be tough.
"Funds that had no exposure to telecom but may be adding some now could be a good play," said Gasaway. "But there are so few of them."
REUTERS
FRIDAY, JULY 20, 2001 3:49 PM
- Reuters
By Jonathan Stempel
NEW YORK, July 20 (Reuters) - It's no secret the collapsed telecommunications sector has punished junk bond investors who thought diversifying was the way to invest in the risky bonds.
The question now becomes: Is the time now right to buy junk bonds, and if so, is avoiding telecom still the way to play?
Also called high-yield bonds, junk bonds are corporate IOUs that carry high yields because of their low credit ratings.
After posting near zero total returns between 1998 and 2000, the bonds' yields soared, typically to above 14 percent, a level experts considered absurdly high.
This year was supposed to be one when the bonds would provide investors total returns in the mid- to high-teens.
It's not happening. Telecom blow-ups have decimated many managers' returns, and turned junk bonds -- again -- into one of the worst-performing U.S. fixed-income classes.
"A lot of bad news has been priced into the market," said Scott Berry, an analyst for fund information service Morningstar Inc. "You can look at the yields on some funds and realize how discounted some of the bonds really are."
SLIDING RETURNS
Junk bonds have returned 3.4 percent this year, down from 8.45 percent in early March, according to Merrill Lynch & Co.
Junk bond mutual funds have done worse, returning 0.87 percent, according to Morningstar. Bank accounts do better.
Merrill Lynch said the bonds yield 8.17 percentage points more than safe U.S. Treasuries, which yield about 5 percent.
Meanwhile, Moody's Investors Service said the junk bond default rate is 8.1 percent, and will hit 10.1 percent by early 2002, the highest since the 13.1 percent peak a decade ago.
The key to performing well in 2001 has been to avoid ambitious telecoms that assumed they could raise huge sums to finance expansion, only to find the capital markets clam up.
PSINet Inc., Winstar Communications Inc. and a slew of others went bankrupt. Better-regarded companies, such as Level 3 Communications Inc. (NASDAQ NM:LVLT) and Williams Communications Group Inc.(NYSE:WCG), have bonds trading at levels that suggest default is more likely than recovery.
The result: The telecom portion of Merrill Lynch's junk bond index has sunk 22.18 percent this year.
So are telecom bonds still a bad bet? Experts are divided.
Kent Gasaway has avoided the bonds, and his $55 million Buffalo High-Yield Fund is up 12.13 percent this year, posting the second best return among junk funds Morningstar tracks.
"When you manage a high-yield fund with a lot of bankruptcies, it consumes your time, it consumes your life," he said. "It prevents you from going out and looking at new ideas. You're spending 80 percent of your time with lawyers."
Gasaway said investors should watch telecom stocks because they are a leading indicator for telecom bonds. The stocks are in sad shape, he said, making it too soon to buy the bonds.
In contrast, Berry said investors should consider diversified funds with telecom bonds. "Funds such as Northeast Investors, which own no telecom at all, have done very well, but could underperform as the market recovers," he said.
RAYS OF LIGHT
There are other signs junk bonds overall may soon improve.
Moody's ratio of rating downgrades to upgrades was 3.3-to-1 last quarter, but that's down from 4.2-to-1 last fall.
According to Merrill Lynch, "distressed debt," which yields at least 10 percentage points more than Treasuries, is consuming less of the market.
And when this year's six Federal Reserve interest rate cuts start to kick-start the economy, that would also help junk. Even, perhaps, junk telecoms.
"If you feel the economy is getting better and liquidity will return to the market, some of your better returns will be in sectors that ... have provided the worst relative returns," said Kingman Penniman, president of high-yield research firm KDP Investment Advisors Inc. in Montpelier, Vermont.
That, he said, could mean portfolio managers who avoided telecom bonds may turn "proactive" and see value there.
Of course, finding those managers now may be tough.
"Funds that had no exposure to telecom but may be adding some now could be a good play," said Gasaway. "But there are so few of them."
REUTERS
