Thursday, May 17, 2007
Investing in 'junk' bonds: Fidelity foursome
Few in the newsletter field have as long-standing an expertise in funds as
Jim Lowell, who publishes several specialized services for this market.
One particular area of noted expertise is in his assessment of Fidelity funds, which he analyzes for readers of his Fidelity Investor. From a recent review of Fidelity’s bond offers, we offer highlights of his favorites among their “junk bond” plays.
“Fidelity Capital & Income (FAGIX) and Fidelity High Income (SPHIX) hold bonds rated below BBB (the definition of “junk”) as well as unrated bonds, some dollar-denominated foreign debt, and even a fraction in common stocks or bonds convertible into common stock.
“In practice, Capital & Income has been somewhat more volatile, in part due to larger holdings in equities (16%) and foreign bonds.
“Fidelity Strategic Income (FSRIX) would appear to take on similar risks, but has been less volatile with its diversified portfolio of about 40% in junk bonds, 30% in US higher-quality bonds, and 30% divided between foreign established and emerging market debt.
“While junk bond funds are the riskiest portion of the domestic bond market, they’re still less risky than stock funds (except for funds like Balanced and Puritan, which hold a mix of relatively stodgy stocks and investment-grade bonds).
“In short, any investor who can afford to take on stock market risks – and most investors with time horizons over 5 years should – can afford to take on junk bond risks. Over the years, we’ve profited handsomely from our stake in Capital & Income.
“While Capital & Income and High Income have average maturities of 8.4 vs. 6.6 years, which would usually mean a duration of about 6 to 5 years, Fidelity does not provide duration estimates for the funds. Their actual 12 month yields are 6% and 7% respectively.
“That’s because durations are pretty had to figure for bonds that are mostly fluctuating based on credit risks: if interest rates shoot up, these bonds might or might not get hit, based on perceptions about economic strength, the reason why the rates went up, and whether those conditions would affect the health of leveraged corporations.
“Fidelity Floating Rate High Income (FFRHX) is basically a junk bond fund with an effective maturity of about a half year. This is more unusual than it sounds, because companies with low credit ratings can’t rely on short-term bonds; at the first downturn, they wouldn’t be able to roll over their constantly maturing debt.
“Instead, they issue longer-term bonds whose interest rates are regularly re-set based on some interest benchmark. (Sort of like a 30-year mortgage whose rate is reset annually.) When buying the fund you get rid of the interest risk, but keep the credit risk.
“Given the relatively decent yields the fund is offering (6.33%), that may be a good deal, but only for investors comfortable with junk (or stock market) risks.”
posted at 11:51 AM
