Junk bond funds pay off in 1st half of 2009 with 23% surge
— -- Bond-fund investors had a great first half of 2009, but the rest of the year won't be as much fun.
The average intermediate-term, investment-grade bond fund gained 5.4% the first six months of the year, assuming reinvested interest, according to Lipper. The average money market mutual fund returned just 0.13%.
Trash turned to gold in the first half. High-yielding, low-quality junk-bond funds soared 22.5%.
But those high returns were just rebounds from the worst junk-bond market in history. Bond traders demand higher yields — and lower prices — when they worry about defaults. Junk-bond yields shot to 20.25 percentage points more than comparable Treasury securities in December, the highest ever.
Currently, junk bonds yield 9.44 percentage points above Treasuries, according to John Lonski, chief economist at Moody's Investors Service. Junk bonds averaged 5.36 points higher than Treasuries in the 10 years ended 2007. In theory, that means junk bonds could generate further gains.
Junk bonds still have plenty of room to get trashed, however: Lonski expects default rates to peak at 12.9% in November — bad news for junk bonds, whose issuers are most likely to go bankrupt. "Industrial companies still struggle with sales that are well under what had been anticipated as recently as summer 2008," he says.
Others agree. "We're going to have a slow recovery, and high-yield bonds have had a bigger run than is justified," says Ken Volpert, head of the taxable bond group at Vanguard.
Investors might fare better in funds that buy bonds issued by more creditworthy companies, Volpert says. Currently, investment-grade bonds yield 3.77 percentage points more than Treasuries, vs. an average gap of 1.04 points in the 10 years ended 2007 — before the credit crunch started.
"That's still pretty attractive," says Volpert. He likes funds that buy short-term investment-grade bonds, particularly those that mature in about two years. "You're picking up a lot of yield without a lot of risk," he says.
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