How good are high-yield (HY) junk bonds for the individual investor? First of all, the HY segment of the corporate bond market is one of the fastest growing areas of the corporate bond market. At the end of 1979 the total amount of low-grade debt -- B- and BB-rated securities -- comprised 11 percent of the outstanding corporate market. By the end of 1984, the amount of outstanding low-grade debt had risen to 18 percent of the total corporate market.
George Collins, the president of T. Rowe Price, which, by the way, began a HY mutual fund the beginning of 1985, has a few thoughts about HY bonds.
"Let's face it," Collins said. "HY bonds are a complicated investment. You're talking about companies that in many instances may have their interest charges earned anywhere from less than one time to perhaps two times. Collins is referring to a company having enough earnings to cover the interest cost on its debt. It takes a lot of work to follow these companies, and a special individual, as well, to do the job. In fact, when we first started the fund, we used our equity analysts to follow different companies because they are so much like a stock. Now, with the fund growing $85 million , we have added the HY bond analyst."
Collins obviously has hit on the most important factor so far as individuals are concerned. Even though HY bonds may yield 250 or more basis points than Treasuries, there are special situations that require a special understanding. (A basis point equals one-hundredth of a percent.) As a result, individual investors should not purchase separate HY bond issues, but should seek the safety of diversification as is found in a mutual fund.
Being attuned to the HY market and to research is certainly critical. Should the U.S. economy slide into another recession, the companies that issue low-grade debt would be the first to suffer. Consequently, it is essential that research analysts are aware of the strengths and weaknesses of these various low-rated companies, and that the investor has the protection of a diversified portfolio in order to protect one's capital in a specialized and credit-risk-sensitive market. Some brokerage firms make available to their wealthy clients special analysts to aid them in selecting individual HY companies. This is a luxury that most of us do not have, but yet it is an excellent service.
Last Tuesday, the Treasury announced its 20.5 billion quarterly refunding. Three issues will be auctioned. A 3-year note in minimums of $5,000 will be offered on Tuesday, A 10-year note in minimums of $1,000 will sell on Wednesday, and a 30-year bond, also in minimums of $1,000, will be offered on Thursday. Investors will be able to subscribe to these issues at no cost by going to the U.S. Treasury in Washington, D.C., or at any of the Federal Reserve Banks or their branches.
If investors go directly to one of these institutions, they should go no later than 1 p.m. on the day that any particular issue is auctioned. Investors also may subscribe to these issues at their bank or through a brokerage firm, but a service charge must be paid. These issues should return 10.10 percent, 11.2 percent, and 11.33 percent respectively.