Junk Bonds Are Due for a Breather

The managers of a top-performing high-yield bond fund have turned cautious.

By Elizabeth Ody, Associate Editor

From Kiplinger's Personal Finance magazine, November 2009

It's been a good year so far for high-yield-bond investors. Consider it payback for 2008, when a flight to quality crushed prices of low-grade debt. The action in 2009, by contrast, resembles a dash to trash. U.S. junk bonds, or those rated double-B and lower, surged 41% year-to-date through September 4. Over the same period, Treasury bonds lost 3%.

The easy money in junk bonds has probably been made already, and they may be due for a pullback. "There's a chance we could see a 10% correction from recent prices, but I don't think prices could retrace their previous lows," says Laird Landmann, co-manager of Metropolitan West High Yield Bond fund (symbol MWHYX). He and his five co-managers have a contrarian bent. They'll shift into safer debt, such as secured junk bonds, when the market looks exuberant, as it did in 2007 and early 2008, but ease into riskier credits when investors become overly fearful, as they did in late 2008.

Recently, the team has become more defensive. At last report, the fund held 19% of its assets in investment-grade bonds. Landmann says he and his colleagues are avoiding debt from companies that depend on consumer spending, and they're overweighting relatively stable energy and utility bonds. With junk still yielding nine percentage points more than Treasuries, Landmann says, the sector remains attractive for long-term investors. "There's still value in the high-quality part of the market," he says. Nevertheless, you should commit any new money with caution.

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