Surge of New Assets Revives Junk Bonds

Money is flowing into junk bond mutual funds faster than at any time since the 1998 Russian debt crisis, providing welcome ballast for the strongest junk bond rally in a decade.

In a sign that the rally may have legs, the funds picked up $488 million in new assets for the week ended Wednesday, according to AMG Data Services of Arcata, Calif. They have taken in more than $2.5 billion in the last four weeks, AMG said.

That’s a seismic shift from last year, when the funds lost $10 billion. A precipitous drop in corporate credit quality and liquidity, and a never-ending stream of poor earnings and sales reports were the big culprits. The funds finished 2000 with just $90.5 billion of assets, about one-quarter off their peak, according to the Investment Company Institute.

It was the Federal Reserve that invigorated junk bond investors, who had suffered through three years of desultory total returns, with its surprise half-point interest rate cut Jan. 3 to keep the U.S. economy out of recession. The Fed cut rates another half-point Wednesday.

“When the Fed eased rates, flows accelerated,” said AMG President Bob Adler. “The inference I draw is that investors are becoming less risk-averse, and their appetite for risk increased because the problems in junk bonds had already been discounted.”

Fund flows are considered a good gauge of investor sentiment for junk bonds, which carry high yields because of their risks. It’s unclear, though, how long the trend will last. Interest rates seesawed throughout January as traders tried to gauge the effect of the Fed rate cuts and at times contradictory economic reports.

Junk bond funds have returned 6.19% this year after dropping 9.16% last year, according to Morningstar Inc. Among big junk funds, Fidelity Capital & Income is up 9% year to date, while Strong High Yield is up 10.7%. By comparison, the Standard & Poor’s 500 index is up only 2.2% this year.

As junk bond prices have soared, yields have slid, to about 12.5% now from 14% at the end of December. The yield gap between junk bonds and super-safe U.S. Treasuries has shrunk to 7.54 percentage points from 8.78 in that time, Merrill Lynch said.

Analysts don’t expect an exact repeat of 1991. That year, junk bond funds returned 36.8%. But the strong start bodes well for the year.

“If nothing else happens, you’re still looking at returns in excess of 15% after three extremely disappointing years,” said Kingman Penniman, president of KDP Investment Advisors Inc.