Supercharged performance.

High-yield bond funds make a comeback

This hasn't been a great year for bond investors. Concerns over the robust economy and fears of rising interest rates have led to poor bond and bond fund performance. The average intermediate government fund had a negative total return of 1.75% through August 31, according to Morningstar Inc., a fund research firm in Chicago. However, high-yield bond funds managed to deliver a total return of 3.22% for the same period. (Total return is the interest earned by a fund, plus or minus any change in the fund's value.)

High-yield bond funds are less sensitive to interest-rate moves than other bonds, according to industry sources. These bonds are more closely tied to the equities market, and their prices fluctuate with the health of the company backing the security, as much as on expectations for inflation and interest rates. High-yields bonds--also called "junk" bonds because they are rated below investment grade--are issued by companies rated BB or lower, as ranked by Standard & Poor's.

Many of these companies are too small or too new to earn an investment-grade rating, while others are blue-chips facing financial difficulties. To make up for the increased risk that the company may default, these bonds pay higher yields compared with safer, high-quality government and investment-grade corporate bonds.

"High-yield corporate bonds yield almost two times the value of the comparable Treasury," says Steven Ruggiero, director of high-yield securities research at Chase Securities in New York City. "By historical standards, that's high" According to the Merrill Lynch High-Yield Master Index, the average high-yield bond yielded 10.46% compared with 5.81% for the 10-year Treasury in mid-summer.

At the head of the pack of high-yield funds in the first half of this year was Dreyfus High-Yield Securities. Fund manager Roger King has delivered a 15.5% gain through June 30--and an eye-catching 14.92% yield--by loading up on bonds of telecom firms, which rallied early in the year, and convertibles of companies like satellite TV company EchoStar Communications Corp. (Nasdaq: DISH).

More than 54% of King's holdings were in bonds rated below B. Analysts say that the average high-yield bond fund has just over 8% in bonds rated below B, making the Dreyfus fund quite risky. King says his fund is for investors seeking total return. The best way to do that over the long term is to purchase lower-rated credits, he adds.

In second place is Loomis Sayles High-Yield Fund, which had a total return of 11.73% and yielded 12% through June 30. The fund received much of its gain by buying blue-chip bonds in beaten-down emerging markets, according to Kathleen Gaffney, co-manager of the fund. The fund has approximately a 40% exposure to Asia and Latin America. The portfolio paid for the extra risk last year when investors fled high-risk securities because of overseas crises such as the Russian devaluation scare. Its total return was -8.87% in 1998.

Gaffney focused on telecommunications and utility companies in those countries. For example, Gaffney says Korea Electric would be a solid investment-grade credit on a stand-alone basis, but because of market uncertainty, it traded at BB spreads.

But such bold bets are a double-edged sword. Both the Dreyfus and Loomis Sayles funds took a beating in 1998, returning -15.84% and -8.87% respectively, compared with the average high-yield funds' return of 0.55%.

And high-yield bonds' fortunes could sour again if interest rates rise rapidly, causing investors to demand an even greater premium over Treasuries. That's what happened back in 1989-90 when junk bonds lost 10% and there was a 12% default rate.

Given the turbulence of the sector, these funds should only be considered by investors willing to accept volatility in return for its potential rewards. As a result, financial planners suggest a 5% limit on junk bonds in the average retail investor's portfolio.

TOP 5 HIGH-YIELD BOND FUNDS

                                          6-Month          1-Year
Fund Name                             Total Return(*)   Total Return

Dreyfus High-Yield Securities             15.52%          -10.22%
Loomis Sayles High-Yield(**)              14.84             2.63
Fidelity Capital & Income                 13.10             9.59
Third Avenue High-Yield                   10.58             2.25
MFS High-Yield Opportunities I(**)         9.16            -2.32

                                         5-Year      12-Month
Fund Name                             Total Return    Yield

Dreyfus High-Yield Securities             N/A         14.92%
Loomis Sayles High-Yield(**)              N/A         10.27
Fidelity Capital & Income                11.50         8.68
Third Avenue High-Yield                   N/A          7.08
MFS High-Yield Opportunities I(**)        N/A         10.33

                                                          Minimum
                                       Toll-Free          Initial
Fund Name                               Numbers         Investment

Dreyfus High-Yield Securities         800-373-9387         $2,500
Loomis Sayles High-Yield(**)          888-226-9699      3,000,000
Fidelity Capital & Income             800-544-8888          2,500
Third Avenue High-Yield               800-443-1021          1,000
MFS High-Yield Opportunities I(**)    800-637-2929      3,000,000

(*) Ranked by cumulative total return as of June 30, 1999. (**) These are Institutional Funds.

Source: Morningstar Inc.

BOTTOM 5 HIGH-YIELD BOND FUNDS

                                       6-Month          1-Year
Fund Name                          Total Return(*)   Total Return

Principal High-Yield B                  0.14%           4.69%
Northstar High-Yield C                 -0.17           -2.59
Delaware Delchester C                  -0.20           -7.30
Delaware Delchester B                   0.20           -7.30
Guardian High-Yield Bond A             -0.44            N/A

                                        5-Year      12-Month
Fund Name                            Total Return    Yield

Principal High-Yield B                  N/A           7.64%
Northstar High-Yield C                  N/A           8.42
Delaware Delchester C                   N/A          10.09
Delaware Delchester B                   6.17%        10.09
Guardian High-Yield Bond A              N/A           0.00

                                                        Minimum
                                        Toll-Free       Initial
Fund Name                                Numbers       Investment

Principal High-Yield B                800-451-5447        $1,000
Northstar High-Yield C                800-595-7827         2,500
Delaware Delchester C                 800-523-4640         1,000
Delaware Delchester B                 800-523-4640         1,000
Guardian High-Yield Bond A            800-221-3253         1,000