As Treasury Yields Wither, Funds & Other Investors Turn to Junk Bonds

Fixed income mutual fund managers and other investors are beginning to move out of Treasuries into higher-risk debt instruments, including junk bonds, and that is good news, BusinessWeek reports. While it may not immediately spur the economy, it is at least helping to change the highly risk-averse mindset of retail and institutional investors alike.

Investors are slowing taking on more risk, not because they are inherently more confident about the economy, but because they are beginning to realize they can’t find any returns in conservative investments, cash and Treasuries notwithstanding, said Jamie Jackson, a portfolio manager at Riversource Investments. Some of the highest-yielding junk bonds are paying as much as 18%.

“Treasury yields dropped to such low levels [by the end of 2008] that they just didn’t make sense anymore, given the supply expected in 2009 and the yield spreads available in other assets that are either implicitly or explicitly backed by the government,” agreed James Sarni, a managing principal with Payden & Rygel.

Mutual fund managers think the risk/reward on corporate bonds is better than owning stock, believes Robert Kowit, senior portfolio manager in the global fixed income group at Federated Investors. “If you have to have exposure to a corporate name [in an index fund] and you’re trying to minimize your risk because of volatility, you might choose to own short- to medium-term bonds instead of equities,” Kowit said.

Investors are also moving into short-maturity FDIC-backed corporate debt, which are paying yields 0.70% to 0.80% higher than Treasuries, as well as municipal bonds.

In addition, there has been a slight increase in Treasury yields over the past month, which Jackson said “shows from a reflationary standpoint, you’re getting some confidence that the Fed and the rest of the federal government will be able to keep us out of a depression.”