Longest Version

Feltus, Top Junk Bond Fund Manager, Prefers U.S. Debt

By Caroline Salas
May 23 (Bloomberg) -- Andrew Feltus, manager of the top-performing Pioneer Global High Yield Fund, expects U.S. junk bonds to outperform those in Europe and emerging markets because the Federal Reserve will refrain from raising interest rates. Feltus, who runs the fund at Pioneer Investment Management in Boston, said policy makers will hold their target interes trate at 5.25 percent for the next 12 months, encouraging economic growth and keeping risk premiums on speculative-grade debt close to record lows. There is about a 25 percent chance the Fed will lift rates to contain inflation, he said. ``My No. 1 risk is inflation,'' not slowing economic growth, Feltus, 38, said in an interview. ``If inflation rises,it would kill the stock market, which would kill risk appetite.'' The $1.8 billion mutual fund has returned 5.9 percent this year, placing first of 15 rivals that buy below-investment-grade debt of companies around the world, according to data tracked by Bloomberg. It has climbed an annual average of 14 percent over three years, ranking second behind the Main Stay Global High Income Fund, which has increased an average of 15 percent. The Fed on May 9 reiterated that inflation is the``predominant'' risk to the economy. Federal Reserve Bank of Richmond President Jeffrey Lacker, who alone voted to raise rates in the last four meetings of 2006, said yesterday he doubts a cooling economy will cause inflation to recede. Growth slowed to a 1.3 percent annual rate last quarter, the worst performance in four years. The central bank's preferred inflation gauge, which excludes food and fuel costs, has exceeded its comfort range of1 percent to 2 percent for about three years.
Spreads Narrow
The extra yield, or spread, investors demand to own high-yield debt instead of Treasuries has narrowed to 2.5 percentage points this year from 2.89 percentage points last year,according to Merrill Lynch & Co. index data. Junk bonds are those rated below Baa3 by Moody's Investors Service and BBB-by Standard & Poor's. ``As long as the economy stays strong, profits will stay good and defaults will not'' rise, said Feltus, who took over the $4.5 billion Pioneer High Yield Fund last month aftermanager Margaret Patel left the firm. ``What drives spreads at the end of the day is defaults.''
Overweight in U.S.
Feltus said the global fund is overweight in U.S. high-yield debt, meaning it has a greater proportion than its benchmark, because of better risk-adjusted returns over European and emerging-market junk bonds. Global High Yield has 57 percent of its assets in the U.S., twice as much as in emerging economies. It has about 10 percent in the rest of the world. ``In Europe, your average new deal is coming with the same spread and'' a higher ratio of debt-to-earnings, Feltus said.``We're always going to go the route of less risk and higher returns.'' The Global High Yield Fund has the highest rating of five stars from research firm Morningstar Inc. in Chicago and a Sharpe ratio of 1.96. The High Yield Fund has three stars and a Sharpe ratio of 0.94. The average for high-yield funds is 1.18.A higher Sharpe ratio indicates better risk-adjusted returns.
Emerging Markets
Global High Yield is underweight in emerging-economy debt because there is more potential for risk premiums to widen than narrow, said Feltus, who joined the firm in 1994 from MFS Investment Management in Boston. Yield spreads for developing countries' bonds fell to 1.50percentage points yesterday, about the lowest since at least1997, according to JPMorgan Chase & Co.'s EMBI Plus index. That compares with an average of more than 6 percentage points in thepast 10 years. Not all investors are as sanguine about U.S. markets. Bill Gross, chief investment officer of Pacific Investment Management Co., said last week the best opportunities ``lie with still unexploited local currency fixed-income markets.'' Gross, who manages the world's biggest bond fund, said Newport Beach,California-based Pimco will invest in more foreign currencies as slowing U.S. growth continues to push down the dollar. The global high-yield default rate was 1.5 percent in April, almost the lowest rate in a decade, according to Moody's.The rate was 1.7 percent at the end of 2006, its lowest year-endlevel since 1996 and its fifth straight annual decline. The global fund's top holding is debt collector NCO GroupInc.'s 11.875 percent bond due in 2014, filings show. Pioneer owns almost $19 million of the $200 million issue, which is rated Caa1 by Moody's and B- by S&P. The investment diversifies Pioneer's overweight bias to cyclical industries such as chemicals because NCO benefits if the economy slows, Feltus said.
Energy Investments
Feltus also is attracted to energy companies including Oklahoma City-based gas producer Chesapeake Energy Corp. and Hilcorp Energy Co. in Houston because of a boom in demand. The price of crude oil has more than doubled in the past five years. Because the companies use hedging strategies to offset potential losses, ``you don't have to predict where oil is,''Feltus said. ``I don't think oil will stay at $65 a barrel forever, but almost all of them make money at $30 oil.'' Within emerging markets, Feltus is bullish on Brazilian food companies, which he said are being helped by lower interest rates. He likes Cosan SA Industria & Comercio, the world's biggest combined sugar and ethanol producer; and Cia. de Bebidasdas Americas, Latin America's biggest brewer, known as AmBev. Feltus is underweight on bonds of General Motors Corp. in Detroit and Dearborn, Michigan-based Ford Motor Co. because they may go bankrupt. Both lost their investment-grade status in 2005and are now rated Caa1 by Moody's and B by S&P. ``There's something wrong with every high-yield company --it could be bad management, a bad balance sheet or a lot of the time it's bad addresses,'' Feltus said. ``With the auto companies, it's all three.''