Junk bonds likely to offer highest returns in '93

January 02, 1993|By Bloomberg Business News

NEW YORK -- Junk bonds offered the highest returns in the corporate bond market last year and are poised to remain No. 1 in 1993, analysts said.

High-yield, high-risk junk bonds "offer the best returns" into 1993, said Jennifer Leichter, manager of Putnam Diversified Income Trust which has $406 million in assets. That's partly because junk probably will get a boost from a rebounding economy while still paying interest rates often several percentage points above investment-grade securities.

"Higher corporate profits will lead to improvements in junk bond credit ratings," Ms. Leichter said.

Higher credit ratings will help raise junk bond prices. Junk bonds are those rated below "BBB-" by Standard & Poor's and "Baa3" by Moody's Investors Service.

Junk bonds provided average returns of 14.45 percent last year, more than double the average 6.02 percent for high-grade corporate bonds, according to data compiled by the Wall Street securities firm Lehman Brothers.

Even individuals who invested in junk bonds last year did well by any investment yardstick. For example,mutual funds that invest only in junk bonds returned 16.19 percent in 1992, almost triple the 5.5 percent for investment-grade bond funds, according to Lipper Analytical Services.

Junk bonds will perform better than high grade bonds next year because "an economic recovery will continue to build up creditworthiness" of lower-rated companies, said David Breazzano, manager of Fidelity Capital & Income Fund, which has $1.7 billion under management.

Mr. Breazzano's fund, which invests half of its assets in bankrupt and distressed companies and half in bonds rated "BB" and lower, had a total return of 25 percent this year. That means an investment of $10,000 in the fund on Jan. 1, 1992, would be worth $12,500 today.

While the recession lingered, bonds of RJR Nabisco Holdings Corp., Chrysler Corp. and Unisys Corp. managed to rally this year as these companies cut costs and otherwise improved their financial health.

For example, a rating increase to investment grade last December helped RJR's 8.625 percent bonds due 2017 climb to $1016.80 per $1,000 face amount bond, from $989.00, providing investors with a total annual return of 11.16 percent. Moody's said the upgrade to "Baa3" from "Ba1" was prompted by RJR's success at financing expensive debt at today's lower interest rates.

Chrysler's 16.875 percent Auburn Hills Trust bonds due 2020 climbed to $1335.00 each, from $775.00 a year ago, providing a total annual return of 76.9 percent. (That's right, 76.9 percent.) The outlook for Detroit's No. 3 automaker improved amid brisk sales of its minivans and new sedans and expectations the company's credit rating will be raised soon. In November, Moody's said it might raise its rating on Chrysler's senior debt from "B1."

In contrast, bondholders of such blue-chip concerns as General Motors Corp. and International Business Machines Corp. watched the value of their investments tumble.

For example, bonds sold by General Motors Acceptance Corp., the financing subsidiary of GM, declined after Moody's Investors Service lowered its rating on GM and its finance unit. GMAC sold $300 million of 10-year bonds in October. The bonds, which pay interest of 5.5 percent, declined to $965.80 per bond, from $1000 when they were sold.

In November, Moody's cut its rating on GM's senior debt to "Baa1" from "A2" and its commercial paper to Prime-2 from Prime-1. About $70 billion of debt of GM and its subsidiaries was affected. Standard & Poor's said it might downgrade the company's senior debt rating from "A-" and commercial paper from "A1."

IBM bonds, once among the safest investments in America, declined after the computer maker said it would take a $6 billion fourth-quarter charge and slash 25,000 jobs. IBM 6.375 percent bonds due 1997 fell to a low of $985.10 earlier this month, to yield 6.74 percent, from a high of $1006.30 shortly after they were sold in October.

Moody's said earlier last month that it may cut its "Aa2" rating on IBM's debt after lowering its rating in March from "AAA." Standard & Poor's said it may downgrade the Armonk, N.Y. based company's "AAA" credit rating.

The junk bond market offers other benefits. Investing in these distressed securities may offer a chance to own equity in companies that are reorganizing, Mr. Breazzano said.

For example, his fund owns about $50 million of Dr. Pepper/Seven Up Cos. Inc.'s bonds. The beverage company is planning an initial public offering of 20 million shares of common stock. As a result, the fund "may end up with some stock or a combination of stock and new bonds at a higher market value than the old bonds," he said.

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