Once vilified, junk bonds make comeback

March 21, 1993|By Barbara Demick | Barbara Demick,Knight-Ridder News Service

NEW YORK -- Fed up with the pitiful rates on certificates of deposit? Tired of Treasuries?

Ever thought about junk bonds?

If you haven't, well, lots of people have. Yes, respectable, middle-class Americans -- the kinds of people who drive station wagons, live in suburbia and are similarly sensible in their investing habits.

Junk bonds are making a surprisingly strong showing in today's economy. The low interest rates offered on higher-grade corporate bonds, Treasuries and deposit accounts have prompted investors to take another look at that most vilified investment of the 1980s.

"They are good buys right now," said Richard Lehmann, president of the Bond Investors Association, a nonprofit group in Florida. "There is a lot of demand because there are so few high-yield alternatives."

Junk bonds are low- to medium-rated corporate bonds that pay relatively high yields to compensate investors for the greater risk of default.

Depending on the quality, junk bonds today yield on average 11 percent. By comparison, 30-year Treasury bonds yield about 6.7 percent, while shorter-term government securities yield about 3 percent.

Moreover, bond analysts say junk bonds are not as junky as they used to be.

In 1990 and 1991, the recession brought an epidemic of bond defaults, many by companies that had taken on mountains of debt to finance buyouts and acquisitions.

The Bond Investors Association reports that in 1990 corporate-bond defaults totaled $28.5 billion; in 1991 an additional $23.3 billion. Last year, default volume dropped to $7.9 billion.

Bond analysts expect default rates to remain steady or to decline, if only because the surviving bonds are among the strongest of the junk pack. The recession, said Mr. Lehmann, "didn't leave too many weak sisters out there."

"Even if the economy were to suddenly sputter out, we shouldn't see another big wave of defaults," added Martin S. Fridson, managing director of high-yield research at Merrill Lynch & Co. "By historical standards, the quality [of junk bonds] is very high."

With junk bonds, as with other corporate bonds, the better the quality, the lower the yield.

Owens-Illinois Corp. and Unisys Corp., of Blue Bell, Pa., have bonds classified in the upper echelons of junk bonds, yielding 9 to 10 percent. Other well-known issues that pay a little better, but still offer relatively good credit quality, are bonds issued by Chrysler Corp. and Grand Union Corp., paying up to 12 percent.

Several caveats are in order: Junk bonds tend to fluctuate more in price than better-rated bonds and can be harder to sell.

"It all depends on your tolerance for risk. You shouldn't look at [a junk bond] as a CD with a 10 percent coupon on it," said Mr. Fridson.

For individual investors wanting to dabble in the junk market, the safest course is to buy through mutual funds. Funds provide investorswith diversified portfolios, minimizing the risk of default.

Even with the superior junk, the risk of default runs 1 in 50.

"Those sound like low odds, but you might have the bad luck of buying three issues and seeing two of them default, " Mr. Fridson said. Last year was the most popular year for junk-bond funds since their peak in 1986. Figures compiled by the Investment Company Institute show that investors poured $5 billion into the funds through November of 1992, double the sales the previous year.

And they were well rewarded:

Lipper Analytical Services, which rates mutual funds, reported that junk-bond funds produced an annual yield of 17.71 percent in 1992. By comparison, the standard corporate bond fund brought investors less than 8 percent, and the average stock fund, less than 9 percent.

One reason for the exceptional performance?

Junk bonds were in such disrepute a few years back that the funds have been able to snap them up at bargain prices. As the market recovered, and defaults leveled off, the bonds shot up in value.

Fund managers are telling investors that they probably will not see that much appreciation this year, but that the junk bonds should still produce handsome returns.

"Last year was the last year of a two-year run that was really quite extraordinary," said Margaret Eagle, a portfolio manager at the Fidelity Group of Mutual Funds. "But the market, as fairly valued, still presents a very good buy."

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