The 200 largest U.S. pension funds increased their allocations to junk bonds by a market-adjusted 36% to almost $14 billion in the year ended Sept. 30.
The Salomon Brothers High Yield index rose 2.5% in the one-year period ended Sept. 30.
A total of 44 of the top 200 funds had money in junk bonds as of Sept. 30. Although 13 of the funds are new to the asset class, another 13 that reported such assets last year no longer are on the list.
"A little extra yield from high-yield (bonds) can go a long way in improving overall portfolio performance," said David Brief, principal at consultant Ennis Knupp & Associates, Chicago.
Many pension executives, he said, have realized they need to boost their bond portfolio return expectations to offset a decline in their return expectations for stocks.
One fund "just putting our toe in the water" is the $20.8 billion Western Conference of Teamsters Pension Trust Fund, Seattle, according to the fund's consultant, Alan D. Biller.
Western Teamsters hired W.R. Huff Asset Management, Morristown, N.J., to manage a $100 million mandate with discretion to invest part of that in high-yield bonds.
As of Sept. 30, Huff managed the fund's entire $80 million in non-investment-grade bonds.
Western Teamsters, Mr. Biller said, needed a manager that specialized in junk bonds, had a long record and was "not trying to blow the lights out."
The $21.5 billion Commonwealth of Pennsylvania State Employes' Retirement System, Harrisburg, again topped this year's list of non-investment-grade bond investors with $1.3 billion invested in the asset class, up 59% from the amount it held as of Sept. 30, 1997.
Florida State Board of Administration, Tallahassee, reported an increase in its investments in high-yield bonds -- to $1 billion as of Sept. 30 from $212 million a year earlier -- which came from a change in the $77.5 billion fund's bond strategy.
Florida unwound a $1.5 billion 8-year-old dedicated bond portfolio, and distributed proceeds to other fixed-income styles, including high yield, said Barbara Jarriel, director of fixed-income investments.
"High yield is such a significant portion of the (corporate) bond market," she said. The fund's target is to have 5% of its fixed-income allocation in the category.
"High-yield (investments) fit very well into our portfolio," she added.
Alcoa has $2.4 billion in dedicated/immunized bonds after reporting nothing in the asset class last year.
A source familiar with the fund said fund officials set up a dedicated bond portfolio because a large group of employees will retire over the next few years, and an asset allocation study showed the company could better match assets and liabilities with a dedicated bond portfolio.
Large funds reporting high-yield bond investments for the first time include:
* State of Connecticut Retirement & Trust Funds, with $840 million ;
* General Electric Co., $679 million;
* Los Angeles County Employees Retirement Association, $652 million ;
* Massachusetts Pension Reserves Investment Management Board, $517 million ;
* SBC Communications, $195 million;
* Iowa Public Employees' Retirement System, $186 million ;
* ITT Industries Inc., $180 million ;
* MetLife, $49 million;
* Prudential Insurance Co. of America, $25 million ;
* Deere & Co., $25 million ;
* PPG Industries Inc., $15 million; and
* Oklahoma Public Employees' Retirement System, $4 million.
"The market for high-yield has exploded," said Kevin Leonard, a consultant for Segal Advisors in Boston.
Many funds have noticed their overall portfolio doing well so they are more willing to take the risk and are a little more lenient when trying something new, he said.
Mr. Leonard works mainly with public funds, which at one time needed waivers from the state to invest in junk bonds. Of his clients, many use enhanced core fixed-income portfolios, which allow up to a certain percentage of assets to be invested in either junk bonds or international bonds.
Jeff Nipp, head of research at Watson Wyatt Investment Consulting, Atlanta, said that his larger clients have dedicated high-yield portfolios, which essentially means they are assuming more of the responsibility for the asset allocation than a fund using an enhanced core portfolio.
High yield did experience a downturn in the third quarter along with other markets, with the Salomon Brothers High Yield index posting a -4.8% return for the quarter, while the Salomon Brothers Broad Bond Index returned 4.1%.
"Clients are aware that high yield is more attractive now than six months ago," Mr. Nipp said.
Phyllis Feinberg contributed to this story.