High Yield Bond Fund Plays It Safe

by Alan Lavine and Gail Liberman

Matthew Kuhns, manager of the Transamerica's Premier High Yield Bond fund, isn't taking chances in this volatile market.

The average high yield bond fund was down about 7 percent last year. Some funds lost 20 percent. By contrast, his fund, which yields 11.9 percent, dropped less than 2 percent.

High yield bonds or "junk bonds" are risky. The bonds are issued by companies with poor credit ratings. High quality bonds are rated single A to triple A by Standard & Poor's and Moody's. They are called investment-grade bonds. High yield or "junk" bonds have ratings that ranges from BB to C.

The high yield bond market is fraught with risks. About three years ago a large number of start-up technology, retail, movie theater and auto supply companies tapped the high-yield bond market for cash. Today they can't pay back their debts due the slowing economy. And rising defaults have sent the high yield bond market into a tailspin.

Moody's Investors Services, New York, predicts 8.5 percent of all bonds issued by poor-credit-rated companies will default by mid-2001. Most of the defaults are in bonds rated B and below.

Over a year ago, Kuhns moved into the strongest areas of the high yield bond market. His average holding is rated BB. He invested in the utility, defense and gaming sectors of this market. He says these are the financially strongest industries.

Kuhns also wants to invest in bonds that could be upgraded and become investment-grade rated bonds in the future. The bond prices rise. For example, Niagara Mohawk, a utility company recently became an investment-grade rated bond.

He looks for companies that have a lot of cash coming in the doors. These are companies that have made it through their start-up phase. They are becoming a more mature business. For example, he expects MGM, a hotel and gaming company, as well as AES and Calpine, which buy electrical generating facilities and L3, a electronics defense industry firm to be upgraded.

The high-yield bond market will turn around when the stock market rebounds, he believes. No one knows for sure when that will happen. But high-yield bond prices move more in line with corporate earnings and stock prices. If future earnings are expected to rise, high-yield bond issuers will have more income to cover their debts.

"We haven't had any defaults," Kuhns says. "We have some bonds that have distressed prices because the overall market has declined. But I think the high yield bond market will bounce back when the stock market turns around."

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "The Complete Idiot's Guide to Making Money with Mutual Funds," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show.

More articles by Al and Gail can be found here.