Time to Invest in High Yield Mutual Funds?

High yield valuations are very compelling. Is it time to invest in this asset class?

In mid October 2008, when the markets were crashing pretty hard, this asset class was one of the worst afflicted. At that time, my view was that High yield values were cheap but they would get cheaper yet. Everyone was selling at that time regardless of the value.

In a post titled, "Are Record Junk Bond Defaults & Outflows Growing Into Opportunities?", John Ogg mentioned some closed-end funds and ETNs such as PHK, HIX, HYV, HYG, JNK. He did not suggest buying them, but mentioned that they would be great buying opportunity at some point. Have we arrived that point?

Here are some performance results for these funds:

* PIMCO High Income Fund (PHK): $3.81 on Dec 17 '08 versus $7.04 on Oct 17 '08. An almost 50% drop in last two months since Ogg's post. On top of the 50% drop from 52-week high he mentioned at that time.

* Western Asset High Income Fund II Inc. (HIX): $4.33 on Dec 17 '08 versus $5.88 on Oct 17 '08. 27% drop on last two months.

* BlackRock Corporate High Yield Fund V, Inc. (HYV): $5.33 on Dec 17 '08 versus $6.94 on Oct 17 '08. 23% drop in that period!

* iShares iBoxx $ High Yield Corporate Bd (HYG) $67.70 now vs $70 then!

* SPDR Lehman High Yield Bond (JNK): $27.89 now vs $32.25 then!

* A mutual fund: T Rowe Price High Yield fund (PRHYX) for comparison purposes: $4.45 vs $5.03 then!


First observation: Closed-end funds have lost much more value than ETNs in last two months or a mutual fund. In fact, the drop in PIMCO's closed end fund is striking (PHK).

Second observation: PIMCO's high income fund (PHK) has been on the news with its GMAC/GM exposure. As GM struggles for its survival and GMAC finds it difficult to convert to bank holding company, this fund has gotten attention with its stand on GMAC debt conversion. Question: Has PHK more exposure to these companies than its peers? Available information indicates that's not the case!

Third observation: Earnings. PHK's P/E is about half of the other two closed-end funds, which are near 4.5. P/E by itself does not mean much, but in comparison PHK looks cheap.

Now: Is it time to buy into these? It is well known that high yield default rates are going up. Pretty much all of this is reflected in price already. PHK's crash shows that, an investment entered on the basis of cheapness, can lose a lot more, especially if it is subject to headline risk.

Corollary of this is that, a long position that lost value due to headline risk will have more of upside potential than downside risk.

For in depth analysis, we look at the discount to NAV, liquidity and more, return profile and the expected technicals especially related to year-end.

Still, at the first glance, it is not hard to say that the risk return potential is compelling for a long position on PIMCO High Income Fund (PHK).

Disappointment with CDS Markets

Sorry State of CDS Markets as summarized by John Dizard of Financial Times:

"Effectively, there isn't any CDS market now."

David Goldman, an old friend and credit strategist turned private investor, still goes through the credit run sheets from the dealers. "The business looks like the window of a Brezhnev-era Soviet butcher shop. Mouldy scraps hanging in the window. Old women lining up at 4am to try and buy credit protection on General Motors. What are reported as trades are really ways to establish prices to satisfy the auditors."

For several years, I have been among those calling for thoughtful, prudent, moderate steps for the reform of the credit default swaps market. They should be put on exchanges, put through central clearing houses, settlement backlogs reduced and then eliminated . . . etc.

I was wrong. The global credit default swaps market should just be liquidated, the contracts allowed to expire and the booby traps defused.

There are three possible defences for treating the CDS market as a going concern: its support for capital raising, its utility for price discovery and its role as a risk-management tool. All have melted like so many Lehman deal cubes in waste incinerators...

Introduction to this Blog

First post here! This blog will talk about my views and outlook on financial markets focusing, drawing from my experience in trading and risk management.

My focus will be credit markets! This is where I have cut my teeth!

I have written similar investor letters before; this is the first time I will make my views available to public. I hope to learn from this!

I expect to post a couple of times a week, more or less.

Your comments and suggestions would be very much welcome.