Investor Demand Continues For Aptly Titled Junk Bonds

FOR thousands of individuals, and some corporations, there's nothing as nice as junk - junk bonds that is.

In October, for example, Carnival Corp., a Miami-based cruise-line company, bought more than $100 million worth of junk bonds - those with high yields but low credit ratings - issued by Kloster Cruise Ltd. The purchase, analysts say, may be used in a possible takeover of Kloster, which runs the Norwegian and Royal Cruise Lines, in Coral Gables, Fla.

So far this year, 142 new junk-bond issues have come to market, with a combined worth of more than $25 billion, according to Securities Data Company (SDC), a financial-services firm in Newark, N.J. That compares with 216 new issues with a total value of $34 billion in 1994. (See chart.)

Even though junk bonds are considered very risky, individual investors continue to pour money into junk-bond mutual funds. The funds are usually called ''high yield'' bond funds, which, though a correct designation, also sounds a lot better than ''junk-bond funds.'' Through Sept. 30, there were about 97 high-yield mutual funds with total assets of $56 billion. That is up from 91 funds and assets of $47 billion through the same period in 1994, notes the Investment Company Institute in Washington, a mutual-fund industry trade group.

Junk bonds are issued by companies or governmental jurisdictions unable to receive a higher credit rating on their debt issues. Usually the issuer is either in financial straits or the industry is relatively new and does not have the longtime financial history necessary to qualify for investment-grade ratings.

The cable television industry, for example, which is relatively new, is a big issuer of junk bonds. Some municipalities and other political agencies must issue junk bonds because they are running large budget deficits and may have difficulty obtaining the revenues to pay off their debt.

With ratings usually below Triple B (BBB), the bonds pay a higher rate of interest than do better-grade issues. But if the issuer is forced into default, bond holders might get back only a fraction of their principal, if that. And junk bonds, like most bonds, are subject to recall and refinancing, at a lower interest rate.

''With interest rates coming down a little and the economy continuing to show modest growth, a number of companies are issuing new junk bonds as a way of increasing cash flow,'' says Richard Peterson, a spokesman for SDC. Junk bonds usually post a return of 2 percent or more over other similar debt issues.

The lowest investment-grade bond - the BBB bond - had a spread, or return, of 1.18 percent more than a 10-year Treasury note at the end of August, notes Morningstar Inc., a Chicago-based financial-services firm. BB bonds, which are usually considered the top of the junk-bond universe, had a return of 2.27 percent more; B bonds had a return of 4.37 percent more; and all bonds of C grade or below (including CC and CCC bonds) paid 9.32 percent more.

Junk bonds have performed well this year, experts note, although exactly how well is a matter of dispute. Morningstar, for example, monitors some 132 junk bond funds; but it only publicly comments on results of 43 funds, says Mark Wright, who covers junk bonds for Morningstar.

According to Mr. Wright, the average return on junk-bond funds through September 1995 has been 13.03 percent. That compares with 12.06 percent for corporate general bonds, and 10.05 percent for high-quality corporate bonds. US Treasury bonds had a return of 12.6 percent. But holders of Treasury issues are sheltered from state and local taxes on their gains.

Some other financial-service firms note slightly different returns, in part reflecting their different portfolios of mutual funds. IBC/Donoghue Inc., a financial-services company in Ashland, Mass., concludes that junk bonds are slightly underperforming high-quality corporate bonds and general corporate bonds. All bond funds, including junk-bond funds, have ''been doing quite well this year,'' says Ralph Norton, managing editor of the IBC/Donoghue ''Moneyletter.''

The underlying trends currently shoring up the world of junk bonds, Mr. Norton says, are ''low inflation and the fact that the [United States] economy is not going anywhere in particular.'' Bond holders like ''steady economic conditions,'' he says.

To buy junk bonds, you can either go through an investment house for individual bonds, or a brokerage house or mutual-fund company for junk-bond funds. For most junk-bond aficionados, and individual investors in general, ''buying mutual funds is the best alternative,'' Wright says. The mutual fund ''provides greater safety,'' since the fund will have a large portfolio of different bonds, which spreads out risk.

Wright is wary of funds that have a large weighting in the very lowest grading tiers, such as C-grade bonds or below. He also suggests that an investor look for a fund with low management expenses.

Most analysts say investors should never use junk bonds for needed current income - their nest egg. Junk bonds have not earned the appellation ''junk'' without good reason.

of 5 stories this month > Get unlimited stories
You've read 5 of 5 free stories

Only $1 for your first month.

Get unlimited Monitor journalism.