Who could blame you if you want-ednothing to do with junk bonds now? With today's credit woes, a category that's populated by highly leveraged companies that rely on quickly diminishing access to credit might not seem like the smartest investment.

Greg Hopper, manager of the Julius Baer Global High Income Fund, begs to differ. He points out that over the past five years through July 31, the S&P 500 Index returned 7.01% annualized. The Merrill Lynch Global High Yield Constrained Index, which Hopper's fund benchmarks against, returned 7.57%. In other words, junk beat stocks—despite the credit crunch. "We were in a raging bull market most of the time—except for the last year and a quarter. Equities should have done well," Hopper says.

This year, through July 31, domestic high-yield bonds are down 4.86%, compared with investment-grade bonds' gain of 2.1%. The Julius Baer Global High Income Fund lost 0.9% over the same period.

Over the years, Hopper's fund has floated atop its category. For the three-year period ending July 31, the fund returned an annualized 5.48%, placing it in the high-yield category's top 2%, according to Morningstar. Likewise, for the five-year period ending July 31, the fund returned 8.37% annualized and bested 97% of its high-yield rivals.

Risk, With Rewards

Today's market is risky, no doubt. High-yield bonds may be shut out of the credit markets or forced to pay so much for debt that it damages issuers' balance sheets.

"Yes, these companies are in a more difficult environment," Hopper says. "But you're also getting paid 800 basis points more than Treasuries to own their paper, so you're getting paid for the risk." He says that even if 10% of his portfolio were to default, it should still net shareholders more than Treasury yields. And the upside potential, of course, is far greater.

Profits from the Crunch

Hopper is a high-income manager; he can venture beyond high yield bonds. Today's volatile market provides plenty of opportunities to put his fund's wide mandate to use, he says.

For example, this year, Hopper took a shine to municipal bonds. He knows it's not typical fare for a fund of this stripe, but the values were too appetizing. The cause was the insurance many munis buy to bring their ratings to AAA. Bond insurers had dabbled in dubious structured finance projects and took losses on collateralized debt obligations, putting themselves on unstable financial footing. Investors worried that insurers were too financially stretched to step up in case of a muni default.

In early March, AAA-rated 10-year munis had an average yield of 4.04%, while Treasuries of the same maturity had 3.55% yields. When the tax-free bonds that are used to finance sewer and road projects began to yield more than Treasuries—a true anomaly—Hopper pounced. He now has a 17% position in standard issue, AA-rated general obligation munis. "That was a relative value play," he says. "When that relationship adjusts again, we will have a lot of capital appreciation."

Another area of particular interest now is bank loans, which are issued by many of the same companies that also sell high-yield bonds. Bank loan prices have cratered this year, as a result of the credit crunch, which has stifled the issuance of new collateralized loan obligations. Prices dipped as low as 86 cents on the dollar—a level that makes the risk and reward characteristics appealing. Fourteen percent of the fund's assets are in these types of loans. "Company for company, loans are more attractive than bonds," he says.

One company whose debt Hopper holds is NewPage, a manufacturer of coated paper, which used a leveraged buyout to purchase Stora Enso North America. NewPage's parent, Cerberus Capital, combined plants. The bank loan Hopper bought was purchased below par and has a floating-rate income of the LIBOR plus 4.50 percentage points. "Given the leverage of the company, we were better off taking a position via loans," he says, noting the fund's first lien on the plant and equipment.

An Equitylike Approach

What about actual high-yield bonds? Hopper likes bonds of companies that are dominant in their markets and have strong balance sheets. High-yield bonds behave much more like stocks than bonds, since the economic environment—not the direction of interest rates—determines their performance. So Hopper approaches individual bond analysis in a manner similar to equity analysis. After all, understanding a company's competitive position and balance sheet reveals its ability to pay creditors, too.

Case in point is Sensata Technologies, a spinoff of Texas Instruments that designs and manufactures sensors and controls. Though its main clients are in the beleagured automotive sector, Hopper says just a third of its auto sales go to North American carmakers. "They're a fairly small piece of the overall price of the products, so there's not much incentive for customers to switch to a different component maker," he says. The B-minus rated bonds are due in 2016 and yield 9%.

Another holding is Cia Energetica de Sao Paulo, a government-owned electric utility in Brazil. The attraction was the 9.75% coupon that's pegged to Brazil's inflation rate, giving the Ba3-rated bonds a good real rate of return. "There's a much longer and deeper experience with inflation in Latin America than we have here," Hopper says. "So you see a lot of these inflation-protected financial instruments."

Ilana Polyak contributes frequently to Financial Planning.