Demand Climbing for Junk Bonds
In a vote of confidence on the economy's outlook, investors in recent days have driven corporate junk bond interest rates to their lowest levels since the modern high-yield bond market was born in the late 1970s.
The hunger for "junk" securities -- so named because they are rated below investment grade in quality -- shows that investors believe the economy will continue to expand next year, analysts say, lifting the fortunes of many indebted companies and boosting their ability to repay creditors.
The demand for the bonds also reflects dissatisfaction with other investment options, including Treasury securities and perhaps stocks, some say.
The annualized yield on an index of 100 junk bonds tracked by KDP Investment Advisors fell below 8% last week for the first time since the index was created in 1990. As of Wednesday, the yield stood at 7.92%, compared with 10.77% at the start of this year.
Bond yields move in the opposite direction of prices: As investors bid aggressively for bonds, the securities' prices rise and yields fall.
The yield on a Merrill Lynch & Co. junk bond index that dates to 1984 also has fallen to about 8% this week, its lowest level ever, the brokerage said.
Kingman Penniman, head of high-yield bond research at Montpelier, Vt.-based KDP, said there had been a sense in the market in recent weeks that some big investors were desperate to own more junk securities, given the optimistic outlook for the economy in 2004.
"I think we're seeing institutional money that believes it needs to get into high-yield bonds by the end of the year," Penniman said.
Daniel Fuss, a veteran bond fund manager at Loomis Sayles & Co. in Boston, said many pension funds, in particular, were looking to junk bonds to help raise their overall portfolio returns.
Many pension funds need annualized returns of 8% or more in the next decade to meet their financial obligations to retirees, experts note. With Treasury bond yields still relatively low, and the stock market's future returns more uncertain after this year's strong run-up in share prices, options for earning 8% or better may have dwindled, Fuss said.
"If you're assuming you're going to earn 8.5%, well, wonderful -- how are you going to do it?" Fuss asked.
Of course, high-yield corporate bonds are no slam-dunk. They bear rich interest returns precisely because the securities are far riskier than higher-quality bonds. Over the last 20 years, many junk-issuing companies have gone belly up, costing their bondholders dearly.
