Investing in Better Quality Junk

At a time when investors hunger for yield, junk bonds look appealing. But if the economy tanks, more high-yield bonds could be downgraded and more issuers could default. If so, declines in the value of the bonds will more than offset those generous yields. In fact, the average junk bond fund has lost money in 2011.

But junk-bond funds are not all alike. Some are way more selective than others and seek to cut risk without sacrificing much, if any, income. One fund that fits that description is CNI Charter High Yield Bond. CNI focuses on senior secured bonds, which have high priority for repayment and are backed by collateral. The fund keeps maturities short—four to seven years, mostly—which dampens volatility in bond prices. Over the past ten years, the fund returned 7.6% annualized, compared with 8.5% for the Bank of America/Merrill Lynch High Yield Total Return Index.

Manager Richard Lindquist, co-managers Patrick Mitchell and Steve Sautel, and an army of 40 researchers and 15 lawyers do serious credit analysis. They look for midsize companies in industries, such as software, that don’t require much cash for daily operations but generate high free cash flow (the cash profit left after the capital outlays needed to maintain the business). And with 233 bonds, no issue represents much more than 1% of the fund’s assets.