There's no need to take a chance on `junk' bond


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Sometimes it pays to be a coward. And for bond investors, this seems like one of those times.

Many bond strategists are warning investors to stay away from high-yield bond funds. During the last three years high-yield, or "junk," bonds gave investors the income jolt they needed while interest rates were unusually low. But now strategists claim there is no need to take chances.

Safer bonds are providing more than twice the yield of two years ago, and high-yield bonds aren't offering enough to make the risk worthwhile in a potentially volatile economy that could see increased defaults.

In early 2003, investors could have tied up money for five years and eked no more than 2.8 percent out of a U.S. Treasury bond. Now they can receive 4.3 percent, while locking up money for only two years. Two-year CDs can be even better, yielding 4.75 percent at some banks. (Search for them at

So why take a chance on high yield?

It's true that high-yield bonds still provide the opportunity for significantly more income than safer bonds. The yield on the Merrill Lynch High Yield Master Index is about 8 percent. But high-yield bond funds have been losing money since September as rising interest rates and fears of a weaker economy have scared investors away.

"Investors who hold on for two or three years might do fine, but in the short term, they are likely to do worse than in Treasuries," said Martin Mauro, a fixed-income strategist for Merrill Lynch Wealth Management Strategy Group.

Merrill strategists are suggesting that individuals hold no more than 5 percent of their portfolios in high-yield bonds. A year ago they were recommending 8 percent.

"You aren't getting paid well enough to take the credit risk," Mauro said.

David Rosenberg, of Citigroup's Private Bank, said: "Play it safe. Preserve capital and get income."

With yields on the riskiest bonds relatively modest, and the economy apparently at a crossroads, Rosenberg is advising investors to be wary of corporate bonds in general - even good-quality bonds.

In a leveraged buyout, he noted, an AA-rated corporate bond can quickly move to junk if the deal burdens a company with huge debt levels.

Consequently, Rosenberg is suggesting that investors should stick with Treasury bonds that mature within three years. Even money market funds make sense, given the uncertainty of the current environment, he said.

Currently, economists are debating whether inflation and interest rates will keep rising in a strong economy, or whether the combination of expensive energy and higher interest rates will slow the economy.

Either outcome would be a threat to high-yield bonds, said Tom Atteberry, a manager of the FPA New Income fund.

If interest rates keep rising, high-yield bonds will lose value because safer bonds will pay enticing levels of interest. And if the economy weakens, shaky firms could have trouble making interest payments and defaults could rise.

As a result, after holding 25 percent of the New Income fund's portfolio in high-yield bonds in 2003, Atteberry said he has cut that back to 5.25 percent.

To be interested in high-yield given economic uncertainties, he said, he'd have to see yields of 10 percent or 12 percent.

"The economy is an open-ended question, and we won't know the answer for several more months," he said.

Readers may leave messages for Gail MarksJarvis at 312-222-4264.

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