Some smarties see value in junk bond rubble

Posted by: Aaron Pressman on August 28, 2007

At some point, despite all the hysteria, the markets will bottom. Rarely does each market segment hit bottom at the same time, however. After junk bonds dropped 3% in July, the worst monthly performance since the post-Internet bubble, Enron-induced panic of 2002, some savvy fixed-income pros say it’s time to buy, Bloomberg reports today.

To refresh your memory, the amount of extra yield over Treasury bonds that junk investors demanded leaped from a record low of less than 2.5 percentage points in early June to over 4.5 points in recent days. While the market is certain to be buffeted by some continued fall-out from the credit crunch, corporate balance sheets remain in good condition — certainly better than the junk market has valued them, managers at firms like Loomis Sayles and Nuveen Investment Management say.

The economic fundamentals will always matter more for bonds that for stocks because, ultimately, issuers pay hard cash in interest and principal or they don’t (excluding the minor niche of wacky deferred pay junk bonds, of course). It doesn’t matter if wireless carrier Alltel (Symbol: AT) remains out of fashion with investors, for example, if you pick up its 7% notes due in 2016 as long as the company stays on its feet. The stock price might suffer but a bond holder will collect a yield equal to about 10% annually as long as Alltel pays.

In addition to putting some dough in one of the funds mentioned by Bloomberg, there’s also the iShares iBoxx High Yield Corporate Bond exchange-traded fund (HYG) that I’ve previously mentioned as a short-term shorting idea. And closed-end funds, as discussed last month, let you pick up diversified portfolios of junk bonds at a substantial discount even to today’s depressed prices. Of the 33 corporate bond closed-end funds listed on ETF Connect, mostly of the high yield variety, discounts range as high as 14%.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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