High-Yield Bonds Are Popular

By IAN SALISBURY Individual investors are snapping up high-yield bonds in what may amount to a leap of faith. After a dismal 2008, prices have rallied, sending the yield of the Merrill Lynch High Yield 100 index down to about 11% from 17% late last year. (Bond prices and yields move in opposite directions.) Since November, individual investors have poured more than $4 billion into mutual funds that hold these bonds, according to fund researcher EPFR Global, helping to drive the surge. Despite hunches that there are still good deals to be had, many financial advisers remain wary, saying individual high-yield bonds are too risky, while vehicles such as mutual funds and exchange-traded funds have frustrating drawbacks that can be magnified by recent uncertainty in the market. High-yield or "junk" bonds are issued by businesses with the least-attractive credit -- issuers that are struggling or untested or already loaded with debt. Buying bonds individually can be hazardous for small investors because unlike stocks -- of which most companies issue just one type -- bonds offer an array of different maturities, interest rates and other features. That makes researching bonds difficult and also keeps trading costs high. Because corporate bonds typically are issued in denominations of at least $1,000 and trade in sizable blocks, it can be difficult to build a diversified portfolio. Taking a big bet on a single name is particularly risky in the high-yield market. The global corporate default rate -- about 4.8% in January, according to Moody's Investors Service -- is expected climb to more than 16% by November, with as many as 300 bond issuers followed by ratings agencies expected to default in 2009. "There is still a lot of risk in individual companies," says David Blain, president of wealth-management firm D.L. Blain & Co. in New Bern, N.C., who favors ETFs. "It's too hard to tell who is going to survive." With so much riding on making the right picks, a fund run by a professional portfolio manager may seem like a natural choice. But if recent results are anything to go by, success of that approach is far from guaranteed. The average high-yield fund is down about 19% in the past year, according to investment researcher Morningstar Inc. While that reflects a tough market, it also masks a wide range of returns, with the best fund down just 0.82% and the worst down 78%, a discrepancy that suggests picking the wrong manager could be as painful as picking the wrong individual bond. Researching funds presents its own set of challenges. Jeff Seymour, managing director at Triangle Wealth Management LLC in Cary, N.C., became interested in high-yield bonds last fall, when the market was close to its nadir. Aiming to minimize his risk, he called a handful of funds to find how many bonds in their portfolios were considered "distressed," with yields 10 percentage points above Treasurys. Not a single one could say. Ultimately, he chose T. Rowe Price High-Yield, based on its low costs and history of posting attractive returns relative to its volatility. But he still isn't totally satisfied with what he was able to learn. "I went with the best information I could glean," he says. T. Rowe Price Group Inc. says that kind of data is not normally reported for its funds, but should usually be available upon request. Stock investors who don't want to depend on a manager can resort to index funds. But bond index funds are rarer than stock funds, in part because the murkiness of the bond market makes them hard to manage. Investors do have the choice of a handful of high-yield index ETFs, such as iShares iBoxx $ High Yield Corporate Bond, which collected more than $1 billion in investor dollars in December and January. But bond ETFs have recently had some high-profile problems, frequently trading at prices that don't seem to reflect the value of their holdings. Moreover, betting on an index means bypassing a lot of what makes high-yield bonds seem so appealing now -- the sense that there are bargains for those who can adeptly navigate a tricky market. Write to Ian Salisbury at ian.salisbury@dowjones.com