5 Jewels Among Junk-Bond Funds

Some funds yield better than 6%. It's hard to top that these days.

To say that the term high-yield bond is a bit of a misnomer nowadays is an understatement. Below-investment-grade corporate bonds, more commonly known as junk bonds, are paying an average of 6.5%. That is a near-record low as measured by the BofA Merrill Lynch U.S. High Yield Master II index. Yet investors are so starved for income that this historically paltry number shines like a diamond trapped inside a lump of coal. So the questions you need to ask are whether the risks of junk bonds justify their low payouts and whether it’s time to buy or to head for the exits before the crowd gets the same idea.

Junk bonds are debt issued by companies with a credit rating of below BBB from Standard & Poor’s or Baa from Moody’s. Yields on junk bonds have often floated in double-digit territory; but a fairer way to determine value in these bonds (not to mention the degree of fear among investors) is to compare their yields to Treasury bond yields. Historically, the gap has fluctuated between six to eight percentage points, although it narrowed to 2.5 points in 1997. But in late 2008, at the height of the financial crisis, junk bonds yielded an astounding 21 points more than Treasuries. Now the spread has closed to 5.6 points. “There’s a scramble for income, and the only place to get it is high yield,” says Kathleen Gaffney, a former manager at Loomis Sayles Bond, a go-anywhere fund that is a member of the Kiplinger 25 and holds 17% of its $22 billion of assets in junk bonds. (See FUND WATCH: Should You Follow Kathleen Gaffney Out of Loomis Sayles Bond Fund?)

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Nellie S. Huang
Senior Associate Editor, Kiplinger's Personal Finance

Nellie joined Kiplinger in August 2011 after a seven-year stint in Hong Kong. There, she worked for the Wall Street Journal Asia, where as lifestyle editor, she launched and edited Scene Asia, an online guide to food, wine, entertainment and the arts in Asia. Prior to that, she was an editor at Weekend Journal, the Friday lifestyle section of the Wall Street Journal Asia. Kiplinger isn't Nellie's first foray into personal finance: She has also worked at SmartMoney (rising from fact-checker to senior writer), and she was a senior editor at Money.