If Stocks Are Bad, Why Are Junk Bonds Good?

REKENTHALER REPORT: Equities may have higher prices, but their reputation remains low

John Rekenthaler 6 June, 2013 | 2:11PM
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Compartmentalising

Everyday investors don't trust stocks. Yesterday, Franklin Templeton asked in an advertisement, rather plaintively, "Is it time to put your money to work? Time to take stock." (A pun!) Merrill Lynch and Wells Fargo bosses are urging advisers to overcome their clients' skittishness about equities. Over the past 12 months, net sales of equity funds have been barely positive, while bond funds have picked up another $300 billion. The shadow of 2008 continues to linger over stock investors.

Yet high-yield bond funds are popular. Cash flows into "junk bond" funds have been consistently positive, running at $10 billion for the trailing 12 months (representing a 4% growth rate on the category's current assets of roughly $250 billion). The Wall Street Journal's Jason Zweig reports that pension plan sponsors are currently considering whether to add high-yield bond funds (among other specialised fixed-income funds) to their line-ups.

I'm not able to square this circle. High-yield bond funds might be called bonds, and stock funds might be called stocks, and, yes, they show up as different colours on a pie chart...but they're much more alike than different. In 2008, high-yield bond funds diversified the plunging stock market to the tune of negative 26%. Junk bonds then roared back to life in 2009--the same time stocks roared back to life. Essentially, junk bonds are yield-cushioned stocks. There's little if any reason to like one security but not the other.

Friendly Fire

If you haven't seen David Snowball's Mutual Fund Observer, take a look. David is a veteran who knows of what he speaks, and he's not afraid to bite. He'll be at Morningstar's Investment Conference next week, using the opportunity to meet with the media and spread his story, but that didn't stop him from nipping at Morningstar in his most recent issue (for, in David's view, poor labelling of a data point). Good for him--who wants a fearful columnist?

Read John Rekenthaler's previous articles here.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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John Rekenthaler

John Rekenthaler  John Rekenthaler is vice president of research for Morningstar.

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