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High-yield bonds extended their strong performance
Investor sentiment improved significantly across credit and equity markets in the third quarter. Investor appetites for yield and risk increased as housing and manufacturing staged modest recoveries and some consumer and labor market indicators stabilized. As a result, lower-quality issuers and distressed sectors led the high-yield market higher. The JPMorgan Global High Yield Index rose 15.08% during the quarter, bringing its year-to-date return to 49.50%. Low-quality CCC-rated bonds jumped 27.70%, while BB-rated bonds advanced a more modest 9.80% during the quarter.
Despite soft second quarter earnings, modest expectations for third quarter earnings and a steady upward advance in the default rate, investors continued to pour cash into the high-yield market. For the year through September 30, nearly $26 billion has flowed into high-yield mutual funds, including $9 billion in the third quarter. Strong demand for higher yields has afforded many high-yield issuers an opportunity to raise new capital through the high-yield primary market. Issuers are taking advantage of improved market conditions to bolster liquidity and refinance near-term bank and bond maturities. Issuers successfully priced 144 new deals ($52 billion) during the quarter. For the year through September, the market has seen 265 deals, valued at $120 billion, came to market. Nearly 80% of new deal proceeds have been directed toward refinancing existing debt, thereby reducing future default risk. Despite an improved market environment, the Moody’s trailing 12-month default rate rose, ending the quarter at 12.0%, up from 10.6% at the end of the second quarter and from 2.75% one year ago. Moody’s has forecasted that the default rate will peak at 12.5% in November and then show dramatic improvement in 2010. Moody’s expects the default rate to fall to 4.5% by next September, below the historical average of 4.7%.
In this environment, the yield spread between Treasuries and high-yield securities narrowed considerably. The yield spread on the JP Morgan Global High Yield Index contracted by 240 basis points for the quarter, ending the period at 779 basis points over U.S. Treasuries. The market spread is now below the previous cycle peaks of 1990 (1,079 basis points) and 2002 (1,080 basis points) and are now 1,146 basis points below their December 2008 record high level of 1,925. Nevertheless, the index spread remains well above its historical median of 490 basis points.
For the third quarter, Columbia Conservative High Yield Fund performed in line with its benchmark, the JPMorgan Developed BB High Yield Index. The fund underperformed its peer group, the Lipper High Current Yield Funds category.
Credit quality allocation and security selection aided returns1
The fund’s modest yield advantage, relative to the benchmark, benefited performance during the quarter. Strong security selection within the utilities, metals and mining, forest products and manufacturing sectors proved beneficial. However, weak relative performance of individual securities within the wireless telecommunications industry partially offset these advantages.
Sector allocation delivered mixed results 1
An underweight position in financials was the single largest detractor from the fund’s performance relative to the benchmark in the third quarter. This was partially offset by an overweight in the wireless telecommunications industry.
Higher-quality focus weighed on results 1
We believe that the fund had more exposure than its peer group to higher quality BB- and B-rated bonds and less exposure to lower quality CCC-rated bonds, which hurt relative performance.
Market Outlook
Strong market technicals, coupled with modest economic growth, have the potential to reduce default risk over the next year. We believe that a peak in defaults is at hand and that the default rate will fall to, or below, historical average levels over the next 12 months. At a current yield spread of 779 basis points over Treasuries, we believe that the high-yield market continues to offer attractive value, both absolute and relative. However, we expect weakness in the labor market and in the consumer sector to limit economic growth. Without strong growth, we remain cautious on lower quality CCC-rated bonds, especially highly leveraged buyout-related deals and weak financial companies. We continue to favor credits with improving credit profiles, ample liquidity and strong underlying asset value relative to their debt. We believe that the fund is well-positioned to capitalize on any market upside, while its higher-quality bias offers downside protection.
Performance data quoted represents past performance, and current performance may be lower or higher. Past performance is no guarantee of future results.
Please read and consider the investment objectives, risks, charges and expenses for any fund carefully before investing. For a prospectus, which contains this and other important information about the fund, contact your Columbia Management representative or financial advisor or go to www.columbiamanagement.com.
The JPMorgan Global High Yield Index is designed to mirror the investable universe of the U.S. dollar global high yield corporate debt market, including domestic and international issues.
The JPMorgan Chase Developed BB High Yield Index is an unmanaged index designed to mirror the investable universe of the U.S. dollar developed, BB-rated high-yield corporate debt market.
Unlike mutual funds, indices are not managed and do not incur fees or expenses. It is not possible to invest directly in an index. 1 Determinations of contributors and detractors are based on performance relative to the fund’s benchmark.
Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts will come to pass. The views and opinions expressed are those of the portfolio managers and analysts of the affiliated advisors of Columbia Management Group, are subject to change without notice at any time, may not come to pass and may differ from views expressed by other Columbia Management associates or other divisions of Bank of America. These materials are provided for informational purposes only and should not be used or construed as a recommendation of any security or sector.
There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. It should not be assumed that any securities transactions or holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions made in the future will be profitable or will equal the investment performance of the securities discussed herein.
Columbia Management Group, LLC (“Columbia Management”) is the investment management division of Bank of America Corporation. Columbia Management entities furnish investment management services and products for institutional and individual investors. Columbia Funds are distributed by Columbia Management Distributors, Inc., member FINRA and SIPC. Columbia Management Distributors, Inc. is part of Columbia Management and an affiliate of Bank of America Corporation. |