Mutual Funds

Why One Junk-Bond Investor Favors Stocks


Fidelity Investments' Mark Notkin, whose high-yield mutual fund beat all rivals over the past five years, says the long runup in junk bonds is over and stocks are now a better buy. The manager of the $12.8 billion Fidelity Capital & Income Fund (FAGIX) is putting more money into equities and into the secondary market for loans made by banks to risky corporate borrowers. And he's cutting back on high-yield junk bonds, which have soared 80 percent since the start of 2009. "I don't see the value in the high-yield market," Notkin says. "You are not being paid to take risk."

In April 2009, Notkin had 5 percent of his fund's assets in stocks, regulatory filings show. The figure was 17 percent in September of this year, according to Fidelity's website. "If I find opportunities, don't be surprised if it gets to 20 percent," says the manager.

Notkin took over Fidelity Capital & Income in July 2003. It's the third-largest U.S. junk-bond fund after the $17.3 billion American High-Income Trust, run by Los Angeles-based Capital Group, and the $13.1 billion Vanguard High-Yield Corporate Fund (VWEHX).

The fund fell 32 percent in 2008, compared with the 26 percent drop in Bank of America Merrill Lynch's (BAC) U.S. High Yield Master II Index, as the financial crisis prompted investors to dump risky assets. At the end of 2008, Notkin saw an "extraordinary opportunity" when junk-bond prices plunged as the credit crisis unfolded, pushing the average yield above 20 percent. "At that point, I thought it made sense to be pressing down on the gas pretty hard," he says. Notkin used the fund's cash stake, which he had built to about 20 percent of the portfolio, to buy the riskiest high-yield bonds—those rated CCC and lower.

The bet paid off. Fidelity Capital & Income surged 72 percent in 2009, compared with a return of 58 percent for the Merrill Lynch index, according to Bloomberg data. In the five years ended Nov. 16, Capital & Income averaged gains of 9.9 percent, the best among 422 high-yield funds tracked by Morningstar (MORN). This year the fund has risen about 14 percent. "This fund is not for the faint of heart," says Miriam Sjoblom, a Morningstar analyst.

When buying stocks, Notkin favors industries such as technology and materials that will benefit from expanding economies in emerging countries. Shares of Teck Resources (TCK), which Notkin acquired in the third quarter of 2009, have climbed 72 percent since Sept. 30 of that year, Bloomberg data show. Vancouver-based Teck, Canada's largest diversified mining company, was the fund's 10th-biggest holding as of July 31. Vehicle-safety-equipment maker TRW Automotive Holdings, another top-10 position, has almost tripled in value over the same period. "We love the auto sector," says Notkin, because the business will continue to grow globally, and companies that sell safety and emissions gear will do especially well as governments around the world force carmakers to raise standards.

With prices on high-yield bonds near all-time peaks and yields at about 7.5 percent, near a record low, investors can expect gains over the next 12 months of about 7 percent, according to Notkin. "The market is fairly valued, if not overvalued," he says. "Compared to high yield, equity is very cheap."

The bottom line: After reaping big gains in junk bonds, Notkin sees more profit potential in stocks positioned to benefit from growth in emerging markets.

Stein is a reporter for Bloomberg News in Boston.

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