Other managers that ranked in the top 10 overall domestic fixed-income universe were SMH Capital Advisors, Inc., Fort Worth, Texas; whose high-income fund came in second, returning 18.4% for the year. Franklin Templeton Investments, San Mateo, Calif., produced a composite performance of its institutional high yield products was 15.6%, propelling it to fourth on the domestic overall list. PENN Capital Management, Cherry Hill, N.J., came in fifth with its core opportunistic high-yield product returning 15.5%. Delaware Investments, Philadelphia, was sixth with a 15.4% composite return for its high-yield bond products, and Loomis, Sayles & Co., Boston, placed seventh by notching a 15.3% return for its high yield full discretion product.
The ability of a high-yield bond manager to select individual securities was key to good performance, as yield spreads between sectors and ratings tightened over the past year, making it difficult for junk bond managers to simply engage in sector rotation to take advantage of widening spreads.
"It was one of those markets where issue selection was really emphasized," said Kathleen Gaffney, vice president and high-yield portfolio manager at Loomis, Sayles. "So what we really looked for was quality in individual names."
Ms. Gaffney added that Loomis' debt and equity research department was used more than ever in the past 12 months to look for high-quality candidates. She said some of the companies whose bonds were high fliers in the past year were found in the single-B or lower spaces: AES Corp., Qwest Communications Inc. and Lucent Technologies Inc.
"We also looked to be overweight in the double-B (rating), because that's where our emerging markets exposure was," said Ms. Gaffney. "Brazil and Mexico were attractive to us in the third quarter."
Tim Rabe, a high-yield bond portfolio manager at Delaware Investments, agreed with Ms. Gaffney about security selection, and said that an emphasis has been put on debt and equity research capabilities at money management firms. "If you look at the high-yield universe, the sectors are pretty compressed. They are all within 100 basis points of each other," he said. "What we've found this year is that distressed names brought in some attractive returns."
Specifically, Mr. Rabe said bonds of utilities AmerenIP (formerly Illinois Power) and Dynegy Inc. did particularly well for the firm. Additionally, E*Trade Financial Corp. also did well. "We bought E*Trade in the new issue market when its bonds were yielding 8%. Those bonds are now up to 106. Our analysts liked its stable bank business."
Eric Green, principal and director of research at PENN Capital, pointed to strong performances of bonds of companies such as Qwest, Dynegy, El Paso Energy Corp. and Williams Cos. Inc.
Eric Takaha, high yield portfolio manager at Franklin Advisers, an affiliate of Franklin Templeton Institutional, said one of the things that have helped improve returns is a decreasing default rate since 2002. "The default rate peaked in 2002 at about 11%," said Mr. Takaha. "Today it is hovering around 2%, according to Moody's (Investor Services). If you look back to last year, it was in single digits. As a result, within the high-yield category, we've certainly seen less dispersion of returns over the past year."
Mr. Takaha noted that bonds of companies in the chemicals and industrials sector helped drive returns, but in general, having investments spread over multiple sectors also helped. "I would say in general there hasn't been the significant variations in performance between industries as we experienced in 2003," he said. "It's more been a matter of individual security selection and being able to avoid distressed and default situations. It really comes down to our research team."
