Investors were lured to invest in high yield bond mutual funds following the financial crisis. And why not, as these funds were a better investment destination since there weren’t enough opportunities elsewhere to seek high yields. These funds provided better returns than those investing in securities with higher ratings, including government and corporate bonds. Also, due to their higher yield feature, these funds were less susceptible to interest rate fluctuations.
High yield bond mutual funds provide the best choice for those looking to invest in below investment-grade bonds, also known as junk bonds. Talking of junk bonds, it surged an incredible 85% in 2011 since its Great Recession low and continued its winning run.
However, in 2015, U.S. junk bonds registered their worst performance since 2008. Rate hike apprehensions throughout the year and finally the lift-off in December dealt a severe blow to these funds. Meanwhile, the weak Chinese economy raised concerns about future demand for oil, eventually dragging global oil prices down. This decline in oil prices also adversely affected junk bond funds.
Activist shareholder, Carl Ichan, has tweeted: “Unfortunately I believe the meltdown in High Yield is just beginning.” Under such circumstances, investors may choose to stay away from high-yield mutual funds. Granted that the outlook is bleak, but still if you are a junk bond investor, we have presented those funds that have turned out to be the best gainers in 2015 despite several bottlenecks. These funds also possess a favorable Zacks Rank that should help these funds to continue gaining in 2016 as well.
What Went Wrong for High-Yield Mutual Funds?
In 2015, the high yield funds category lost an average 4.1%. Anticipation of a rate hike for the first time in nearly a decade and finally the Fed hiking its benchmark interest rates in December had a negative impact on the junk bond market. The Federal Reserve’s easy monetary policy for the last several years, which kept interest rates at record low, had been a boon for the junk bond market. Investors had flocked to this market in search of bigger payoffs.
Following the Fed rate hike, net outflows from high-yield bond funds were $3.8 billion in the week ending Dec 16. It marked the third largest outflow on record and the largest since 2014, according to Lipper. During December, net outflows totaled $6.29 billion, higher than November’s net outflow of $3.3 billion. With this outflow, total outflow of high yield bond funds for 2015 came to $13.88 billion, with high-yield funds posting a negative flow in 7 out of 12 months of 2015.
The adverse effect could easily be spotted when New York-based Third Avenue Management blocked investors from redeeming money from the near $1 billion Third Avenue Focused Credit Fund last December. The failure and the embargo on investors on withdrawals also highlighted the concerns related to liquidity in corporate bond markets.
The continuous slide in commodity prices also affected junk bond funds. Decline in commodity prices means that energy and material companies may soon have trouble repaying their debts, as they constitute a major portion of the high-yield bond market. Fears about economic slowdown and market volatility in China were instrumental in the plunge in commodity prices.
Fed Rate Hike
Through 2015, Fed rate hike expectation kept high-yield funds under pressure. Ultimately, on Dec 16, the Fed raised its key interest rate for the first time in nearly a decade. The Fed increased its short-term borrowing rate to a range of 0.25% to 0.50%.
Meanwhile, the Fed stressed that the pace of rate hikes will be ‘gradual’ in nature. The junk bond market had been a strong beneficiary of low interest rate and capital had flowed strongly into the debt sector. However, the lift-off spooked investors and they started exiting junk bond positions.
Weak Chinese Economy and Oil Price Slump
China’s economy and financial markets suffered for a large part of 2015. Economic data remained weak through the year though markets soared during the first half of 2015. Ultimately, markets crashed over a two and a half month period, erasing nearly $5 trillion in value terms. A bubble had built up steadily and valuations had hit levels which were difficult to justify.
Weak Chinese economic data raised concerns about decelerating growth in the world’s second largest consumer of oil, which eventually dragged oil prices down. Additionally, persistent supply glut and a stronger dollar also adversely affected oil prices. Price of a barrel of U.S. crude was down more than 30% in 2015 from year-ago levels.
Meanwhile, the U.S. economy hardly helped high yield funds in 2015. For the first three months, it expanded at an annual rate of 0.6%. The growth was mostly affected by harsh winter weather and disruptions in West Coast ports. However, the economy picked up pace in the second quarter, gaining 3.9%, but slowed down to a gain of 2% in the third quarter.
Best Performing High-Yield Mutual Funds in 2015
In 2015, the junk bond market had a torrid ride due to decreasing liquidity within and rising borrowing costs. Moreover, concerns about junk-rated energy and material companies’ ability to repay debts due to fall in commodity prices continued to weigh on junk bonds.
As declines outweighed gains, the funds finishing in the green could post only modest gains. Below we present the best-performing high yield mutual funds of 2015, which are under Zacks Mutual Fund coverage. We have considered those funds that have a minimum initial investment of $5000 and net assets over $50 million.
From the above list, we present the top five best-performing high yield mutual funds of last year. These funds also possess a relatively low expense ratio and boast a Zacks Mutual Fund Rank #1 (Strong Buy).
Aquila Three Peaks High Income Y (ATPYX - Free Report) seeks high current income. ATPYX invests a large portion of its assets in income-producing securities. Its portfolio includes high-yield/high-risk securities rated below investment grade. ATPYX currently carries a Zacks Mutual Fund Rank #1. ATPYX’s 3-year and 5-year annualized returns are 3.6% and 4.8%, respectively. Annual expense ratio of 0.94% is lower than the category average of 1.06%.
Buffalo High-Yield (BUFHX - Free Report) invests a major portion of its net assets in higher yielding, higher-risk fixed income securities. BUFHX currently carries a Zacks Mutual Fund Rank #1. BUFHX’s 3-year and 5-year annualized returns are 4.1% and 5.2%, respectively. Annual expense ratio of 1.02% is lower than the category average of 1.06%.
Credit Suisse Floating Rate High Income A (CHIAX - Free Report) seeks high current income. CHIAX invests in a diversified portfolio of high yield and high risk fixed income securities (junk bonds). CHIAX currently carries a Zacks Mutual Fund Rank #1. CHIAX’s 3-year and 5-year annualized returns are 2.3% and 4%, respectively. Annual expense ratio of 0.95% is lower than the category average of 1.07%.
Wells Fargo Short-Term High Yield Bond A (SSTHX - Free Report) seeks total return and invests primarily in medium and lower quality corporate debt obligations. SSTHX currently carries a Zacks Mutual Fund Rank #1. SSTHX’s 3-year and 5-year annualized returns are 1.9% and 3.1%, respectively. Annual expense ratio of 0.81% is lower than the category average of 1.06%.
MassMutual Premier High Yield I (MPHZX - Free Report) seeks to achieve a high level of total return and mostly invests in high yield debt and related securities. MPHZX currently carries a Zacks Mutual Fund Rank #1. MPHZX’s 3-year and 5-year annualized returns are 3.8% and 10.1%, respectively. Annual expense ratio of 0.55% is lower than the category average of 1.06%.
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