As the financial markets gyrate amid worries about high-risk takeover debt, small savers and investors need not feel left out of the action.
They can get in on the game simply by putting their money in a mutual fund that owns a portfolio of high-yield, or "junk," bonds of the type used to finance many corporate buyouts in recent years.Whether anyone would want to get involved in such a chancy proposition, of course, is another question entirely.
The market for junk bonds has been unsettled for months now, and lately it has suffered a series of setbacks. The most recent came just a few days ago when a group planning to buy UAL Corp. said bankers had balked at financing the deal.
Even in the best of times, junk bonds must offer higher yields than other, higher-quality securities in order to attract investors. In periods of heightened uncertainty, the yield differential naturally tends to widen.
Thus, junk bond mutual funds today sport yields in the 13 percent to 14.5 percent range, compared to roughly 7.5 percent to 8.5 percent for funds that concentrate on safer investments like U.S. Treasury bonds, which are guaranteed against default by the federal government.
On a $10,000 investment, that's a difference in interest payments (technically called dividends when they are distributed by a mutual fund) of some $550 to $600 a year.
Is that disparity enough to justify taking the risks that come with junk bonds? It all depends, financial advisers say, on your ability to withstand losses and your view of the economic outlook.
Just about everybody agrees that junk bond funds are a bad choice for conservative investors who depend on reliable income, and safety of principal, to cover their costs of living.
Even willing risk-takers have to be wary of some potentially misleading impressions before they can make a sensible appraisal of the risks and rewards in the junk market.
First of all, points out Norman Fosback, editor of the newsletter Income & Safety, the nominal yield cited at any given time for a portfolio of junk bonds must be considered an exaggeration.
"Many of the high-yield issues are bound to default," he says. "Indeed, their ultrahigh yield is both a recognition of that inevitability and a compensation for the corresponding risk."
As a rule of thumb, a prospective buyer might subtract 3 percentage points from the stated annual yield to allow for defaults.
Another variable that can hurt the return on a junk bond portfolio is a decline in prices. This can occur even in a period when interest rates are steady or falling, if confidence in the market suffers as it has this year.
According to Donoghue's Moneyletter, three of the biggest junk bond funds, carrying stated yields of 12.8 percent to 14.5 percent, actually managed to post "total returns" of only 5.4 percent to 5.6 percent for the first nine months of 1989.
You could have done better than that in any one of numerous other, much less risky investments.
Donoghue's concludes, "The premiums the funds are now paying over Treasury yields are large, but they should be. The funds are no bargain now."
Fosback, by contrast, argues that junk-bond funds have fallen so deeply into disfavor that they have some appeal for venturesome investors of a "contrarian" bent.
He contends that it may be a good time to buy them "if you can stand the fluctuations and the excitement."
One long-time bear on junk bonds, James Grant, argues that the very expression "high yield" embodies much that is wrong with the financial world right now.
"What investors have chased in the 1980s is yield - not total return, but promised rates of interest," he observes in his Grant's Interest Rate Observer. "Promoters have sold it and investors have bought it."