One of my all-time favorite columns was penned by Bob Bobala, editor-in-chief of The Motley Fool. (And I'm not saying that just to suck up, either.) Seriously, who doesn't want to Get Paid to Invest? If you're in search of fat payout pitches (a.k.a. stocks that pay generous dividends), go check out that article right now. As an added bonus, you'll hear how Bob avoided the tech sector meltdown. Now how much would you pay? (Just joking. It's free.)
I do have a small quibble with the column, however. There's one payout opportunity that Bob didn't mention: mutual funds. That's right, plain old, everyday, you-know-you-own-'em mutual funds. More than 90 million of us drive this particular investment minivan. In fact, my Champion Funds newsletter service is dedicated exclusively to helping you find those that can give you a smooth ride and high-octane returns. (Click here to try it for free.)
As you'd imagine, a good many funds are run by managers who have a hankering for companies that return cash to shareholders (in the form of dividends) rather than sinking it into schemes that would probably just weigh on their return on invested capital (ROIC) anyway. But my focus today is elsewhere: With mutual funds, we can invest responsibly in one of the highest-yielding asset class of all: so-called "junk" bonds.
Junk bonds get a bad rap, in large part, due to their name. I'd certainly never call up my broker (even if I had one) and ask for the latest hunk of junk. Buying individual high-yield debt issues is just too risky for my blood. On the other hand, buying a well-chosen basket of the suckers can be a viable (and Foolish) proposition. How so? Well, when it comes to navigating market cycles, diversification should be your watchword. When, for example, large-cap growth stocks fall from favor, the small-cap value picks in your portfolio can help take up the slack and cushion your returns.
The principle is much the same in the universe of fixed-income. When an economic recovery gets under way, high-yield bonds (and the mutual funds that buy them) tend to be among the best performers. That was certainly the case when the market began to rally in late 2002. And high-yield funds kept up the good work through most of 2003. According to data from mutual-fund researcher Morningstar, the typical high-yield bond fund returned nearly 24% last year. And guess what? That same "typical" fund currently sports a coupon in excess of 8%.
It pays to be picky
Recent short-term performance is never a good reason to invest in anything, of course, and to be sure, even high-yield mutual funds can be plenty volatile. Moreover, fat 'n' juicy though it is, try not to get too mesmerized by that 8% average payout figure. With both stocks and bonds, total return is the number to watch. After all, if price erosion takes back what the yield gives, you're not really earning a thing. Those caveats aside, when they're used in discriminate doses, high-yield funds can make terrific portfolio diversifiers -- all while throwing off a wad of cash.
But don't imagine that just any old fund will do. When I work on ferreting out high-yield keepers, I use much of the same criteria that I've brought to bear on my equity picks in Champion Funds. Among other things, I need to see an experienced manager, low expenses, and a strategy that's delivered the goods over a long stretch of time. Moreover, because credit risk is the bugaboo when it comes to high-yield investing, I also tend to favor funds with crack researchers, whose ability to tear apart corporate debt structures -- and avoid major blowups -- is borne out by the long-haul performance of the funds they work on.
Making the grade
One fund that measures up in all respects is Vanguard High-Yield Corporate. An actively managed pick from a shop best known for index funds, High-Yield Corporate comes equipped with manager Earl McEvoy, who began calling the shots back when Ronald Reagan was entering his second term. McEvoy hails from Wellington Management, the highly regarded firm that "subadvises" this fund for Vanguard, and his tenure has coincided with an outstanding performance record.
Indeed, for the 10 years ended May 2004, the fund has notched an annualized gain of more than 7%, a figure that stands head and shoulders above most of the high-yield competition. A comparatively tame approach to issue selection burnishes its appeal. Non-rated bonds barely make a blip in the portfolio, and debt-rated CCC or lower hardly registers, either.
Instead, "junk" bonds issued by such established firms as Nextel
And so, I leave you with not one but two cherries on top: This fund's payout currently hovers around 7%, and its expense ratio weighs in at a dirt-cheap (and very Vanguard-like) 0.23%. Income-hungry investors should compare that with their brokerage fees and proceed accordingly.
S hannon likes all junk shops, some junk bonds, and even the occasional gambling junket. He doesn't own any of the funds or companies mentioned above, but that's not to say he doesn't like them, too. The Motley Fool is investors writing for investors.