The fund's largest sector holdings include nonconsumer cyclical, capital goods and basic industries. The largest holdings include Ivax Corp., a generic drug company with growing sales; Crescent Real Estate, which has strong demand for its Texas properties; and Freeport-McMoRan, which is benefiting from the rising cost of gold. Largest industries include capital goods, industrial products and services.
Going forward, fund managers say strong, sustainable economic growth should result in double-digit returns. "Balance sheets are getting strong and new issuance looks stronger," says Kevin Akioka, manager of the Payden & Rygel High-Yield Bond Fund. "Yield spreads are attractive, and companies are deleveraging."
Akioka says that this new focus on deleveraging is making the high-yield bond market much stronger today. "The valuation and yield spreads on bonds are high enough so that strong economic growth isn't necessary for the bonds to perform well."
Akioka's fund is overweighted in homebuilders, gaming, paper and forest products and health care. The fund's average holding is rated BB-. Like many managers, he favors lower-rated issuers instead of fallen angels. The reason: Many fallen angels have weaker bond covenants than bonds initially rated B. Plus, many B-rated issuers are using cash flow to pay down debts.
Some of his fund's largest holdings include Allied Waste, the country's second-largest waste management company, and Williams Scotsman, the country's second-largest mobile office and storage company. Allied Waste bonds yield 10%. The company has solid cash flow and is paying down debt. Meanwhile Williams Scotsman's bonds yield 12%. Cash flow is stable and growing.
Despite improving fundamentals, not all managers are sanguine about the market. James Caywood, manager of the Enterprise High-Yield Bond Fund, believes that the economy may slip back into a recession. Later this year, it should recover and grow at a 3.5% rate. "The uncertainty of war is leading to slower consumer spending and continued pressure on profits and corporate financial strength," he stresses.
Although most fund mangers stick with B-rated issues because the yield spreads are at historical highs in relation to Treasuries, Diane Keefe, manager of the Pax World High-Yield Portfolio, is playing it safe and is sticking with upper-tier credits. "I intend to manage with a conservative bias in an effort to reduce volatility and protect against the downside that could arise from a U.S.-Iraq military conflict," she says.
On the plus side, if the stock market performs well, high-yield bonds follow suit. Even if the stock market remains flat, high-yield rates look attractive. But if the economy slows and stocks decline, high-yield bonds may continue to underperform Treasury and high-grade corporate bonds, as they have for the past two years.
The total return on high-yield bonds typically has done well following a bear market in stocks, according to research by the No-Load Investor, an Ardsley, N.Y., newsletter.
The average diversified equity fund lost 26% in the September-to-November bear market of 1987. Over the next year, stock funds gained 21.5% and high-yield bond funds gained 11.9%.