While many portfolio managers are looking to take profits after the massive junk rally that began last October, a high-yield strategist argues that the sector is actually more attractive now on a risk-adjusted basis. Christopher Garman, strategist at Merrill Lynch, has analyzed the performance of high-yield issues over a 15-year period and found that rising prices for junk bonds often coincide with reduced risk. "People talk of the impact of simple high prices on future total returns because they are limited on the upside by call options, but the risk/reward relationship for high-yield tends to improve as prices go up," Garman says.
The risk/reward relationship is especially attractive in the more speculative triple-C and single-B issues, according to Garman's thesis. By contrast, double Bs are less attractive on a risk-adjusted basis as their prices go up, and triple-Bs, which are at the bottom of the investment-grade ratings ladder, actually post low to negative returns as they increase in price, Garman says.
Investors do not seem prepared to act on Garman's counterintuitive analysis, however.Tom Marthaler, who manages $19 billion for ABN AMRO Asset Management in Chicago, says he is more inclined to buy double-B and triple-B credits at this point. He is concerned that a number of portfolio managers who have ridden more speculative credits to sizeable gains will sell those first as they look to lock in their profits. Some of the sellers may also be equity investors who had been hiding out in the high-yield market and are ready to buy stocks again, he says, adding, "it certainly wasn't improving fundamentals that got people here in the first place."