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High Yield Bonds: Are They Too Good to Be True Right Now?
By Dr. Steve Sjuggerud, Chairman, Investment U
Monday, August 29, 2005: Issue #465
Now that stocks are expensive, and real estate price tags are too big (according to Alan Greenspan), is it time to invest in high yield bonds?
In short, the answer is no
Bonds of companies that seem to have any risk at all are a bad deal right now. In particular, I suggest you avoid the temptation to invest in junk bonds (also known as “high yield” bonds), and emerging market bonds. Why?
A lot of investors are attracted to high yield bond funds right now, with yields in the neighborhood of 6.5%. But the risks these funds must take with your money to earn those attractive-looking yields are just not worth it.
With an increasing amount of borrower defaults and looming bankruptcies, you can lose good money here
Yes, You Can Lose Money in High Yield Bonds
Here’s what I mean:
High yield bonds actually lost nearly 10% in 1990 and then roared back for a few years. They lost money again in 1994, and 2000 and 2002. You’d have lost money in four out of the last 15 years.
The last two years have been good, and investors are looking for new places to put their money. But after a big run, high yield bonds are not the place to invest.
Take a look in the chart below:
Total returns on the Lehman High Yield Bond Index, 1990-2004
| 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 |
-9.59% 46.19% 15.75% 17.12% -1.03% 19.17% 11.35% 12.76% 1.87% 2.39% -5.86% 5.28% -1.41% 28.97% 11.13% |
The Dean of High Yield Speaks
Martin Fridson is widely considered “the dean of high yield.” He’s done more homework and made more good calls than anyone in this field in the last 15 years. In today’s Barron’s, Marty issues this major warning about his specialty, risky bonds:
“An already-risky segment of the investing landscape [high yield bonds] is sure to get even riskier. That should be apparent over the next few years, when the bankruptcy dockets almost certainly will be teeming with activity. The credit quality of newly issued highyield bonds nosedived in the undiscriminating investment environment of 2003-2004. Typically, defaults and bankruptcies surge a few years after such episodes.”
Marty says a lot of money has flowed into these risky assets in recent years. And his homework shows that after money flows in indiscriminately, people lose money.
We’re at that time now.
Don’t get excited about attractive, high yield bond funds and emerging market bond funds. The downside risk is much greater than the upside potential at this point.
And if you’re overloaded with these, lighten your load at the current high prices.
Good investing,
Steve
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