SPDR Barclays High Yield Bond (NYSE: JNK) carries a 7.7% listed yield and is up 0.25% at $39.00 against a 52-week range of $34.09 to $40.93 and it is the primary ETF we look at when it comes to the world of high-yield or junk bonds.  Then there is the iShares iBoxx High Yield Corporate Bond (NYSE: HYG) up 0.1% at $89.69 with close to a 7.7% yield and a 52-week range of $77.90 to $92.85, followed by the PowerShares Fundamental High Yield Corporate Bond Portfolio (NYSE: PHB) that is flat at $18.34 with a yield of about 6% and a 52-week range of $17.00 to $18.76.  You have to consider that the 10-Year Treasury yields close to 2%, but high-yield and junk bonds often pay 7%, 8%, or more.  Here are some of the top closed-end funds, although there are many more out there:

• Blackrock Corporate High Yield (NYSE: HYV): market cap of $396 million with shares up 0.3% at $12.02; 52-week trading range of $10.10 to $12.60; implied yield of 8.5%.
• Pioneer High Income Trust (NYSE: PHT): market cap of $480 with shares up 0.7% at $17.07; 52-week trading range of $14.12 to $18.08; implied yield of 9.6%.
• PIMCO High Income Fund (NYSE: PHK): market cap of $1.5 billion with shares down 0.1% at $12.62; 52-week trading range of $10.52 to $14.88; implied yield of about 8.5%.
• AllianceBernstein Global High Income Fund, Inc. (NYSE: AWF): market cap of $1.2+ billion with shares up 0.9% at $14.47; 52-week trading range of $12.43 to $15.41; implied yield of 8.3%.
• Western Asset High Income Fund II Inc. (NYSE: HIX): shares are up 0.4% at $9.84; 52-week trading range of $8.35 to $10.45; implied yield of about 10.0%.
• Western Asset High Income Opportunity Fund Inc. (NYSE: HIO): shares are up 0.8% at $6.32; 52-week trading range of $5.34 to $6.63; implied yield of 8.0%.

We do advise investors to study the current premium and discount that each closed-end fund trades at compared to the net asset value.  Some are discounts and some are premiums, and these can fluctuate wildly through time for a myriad of reasons.

While that is a composite and while the “BB” is now under 500 basis points over Treasuries, the “B” spread is now under 750 basis points over Treasuries.  Maturities matter here as the longer-dated notes and bonds command higher spreads than most shorter-dated instruments.  Still, this could be the beginning of a wave of continued interest in junk bonds.

What is interesting is that rising yields in Treasuries implies losses on the face value of bonds.  If the yields are rising because of an improving economic picture rather than because of inflation or because of a lack of faith in the underlying creditworthiness of the government, then the bond spreads are likely to contract further and that would drive the interest into high-yield junk bonds.

Be advised that not all junk bond funds are created equally outside of the ETFs.  Some closed-end funds use domestic junk bonds only, while some use international bonds.  Some include foreign-issue sovereign debt at junk levels or trading as though they are junk.  Aslo, some use a bit of leverage while others do not.  The dividend yields are “implied” because ethe closed-end funds pay monthly.

Another caveat needs to be mentioned… Some of the yields on financial quote screens also will differ from our implied yields because we do not include the capital gain distribution that comes with many of these.  They of course count toward your total return, but we like to look at the most recent ‘regular dividend’ when calculating yields.

We have provided a chart for the “JNK” ETF Below so you can see how much this sector has risen since Thanksgiving and then again since the selling climax of stocks and risk instruments (including junk bonds) in early October.

A true chartist would tell you to watch this current level closely.  If prices do not rise from here, it could be representative of a false break-out and that would imply a near-term top.  As long as the “risk-on” mentality prevails, these should do well.  The trick is watching longer-term Treasury yields.  With close to a 2% yield on the 10-Year Treasury Note, investors will seek higher returns as long as those returns are likely to have at least some degree of price stability.  If investors think that Treasury yields are likely to climb suddenly to 3% or even 4%, junk bonds will have some competition from the risk-free trade again.

As you would expect, there is no such thing as a free lunch in the financial markets.

JON C. OGG

Imagine the rate which companies of lower credit have to issue debtat to attract investors today.  Now throw in outflows from fundmanagers who manage junk bond funds only adding to the lack of liquidity.AMG recently noted more than $470 million flowed out of junk bond fundsa week ago and said some $590 million was the latest week’s outflowsfrom junk bond funds.  That is the equivalent of losing the assets ofseveral entire closed-end bond fund per week.

A week ago we saw a report from Moody’s showing that the junkdefault rate would rise sharply to 4.2% by the end of 2008.  It alsosaid default rates could jump to a sharp 7.9% one year out.  Moody’ssaid that September’s default rate of 2.8% was the highest in fouryears and double the rate of a year ago. Now S&P has put junkdefault rates at even higher levels.  By September 2009 it seesdefaults reaching 7.6% and under its pessimistic scenario it noteddefault rates running possibly as high as 9.6%.

Reliant recently paid 14% for its capital depending upon yourcalculation.  To make matters worse, many junk rated companies have tostart issuing debt again next year.  If the credit markets stay verysoft along with highly volatile markets and a weakening economy withrecession numbers just hitting the tape, then many junk bond holdersare going to find themselves asking how much more risk they are willingto take on.  Wait until defaults actually do start to post seriousgains and see how investors will treat the junk bond field.

Some of the closed-end funds and ETN’s below will spell out some ofthe carnage we are seeing as a result of recent volatility and creditmarket malaise:

The PIMCO High Income Fund (NYSE: PHK) closed down almost 3% Fridayat $7.04.  This is down 50% from its 52-week high of $14.10, and theyield is now over the whopping 20% mark.   

The Western Asset High Income Fund II Inc. (NYSE: HIX) closed upover 2% at $5.88 today and it too has nearly lost half of the valuefrom its 52-week highs.  Its yield is roughly 18% at the currentdividend rates.

The BlackRock Corporate High Yield Fund V, Inc. (NYSE: HYV) closedup 4% Friday at $6.94 and it has also lost close to half its value overthe last year and now yields roughly 18% at current payout rates.

For an ETN, the iShares iBoxx $ High Yield Corporate Bd (AMEX: HYG)has lost more than 30% of its value from highs of the last year and itsdividend at current rates is north of 10% if those payouts are steady.

For another ETN, the SPDR Lehman High Yield Bond (NYSE: JNK) haslost close to one-third of its value and after a near-6% drop Thursdayand another 1% Friday its yield is over 12% at current payout rates.

At some point these will become almost too cheap to ignore. Junkbonds are at spreads and levels that have never been seen in most ofour careers. But the other issue is that investors have been fleeingthe sector relentlessly and we are formally just entering the recessionnow.  Wait until investors actually start reading about all the junkquality bond defaults reaching levels that haven’t been seen since the1980′s since before a zany man named Michael Milken entered the stage.

Closed-end bond funds used to trade at high premiums to their net asset values, but now most trade at substantial discounts. Tight credit markets have always unlocked before. Bad times do always pass.  In the end, there will have been one great opportunity to buy these funds at a major discount.  Whether that time is now or in 2009 is still an unfinished chapter. 

Jon C. Ogg
October 18, 2008