Turning To Chapter 11 Junk For Big Risks And Rewards

As the junk market recovers from its battering, Fidelity Investment's Capital & Income fund is poised to profit. Back in December, 1990, Fidelity got investors' approval to adopt a more aggressive strategy for managing what was then the Fidelity High Income Fund. Instead of shying away from the riskiest and most lucrative part of the market--namely, the highly illiquid bonds of companies near or already in bankruptcy--Fidelity plunged in.

The tactic is designed to make the giant mutual-fund company the most powerful buyer of junk bonds and give its retail investors a chance to play alongside such bankruptcy mavens as Carl Icahn. Such pros buy the bonds at depressed prices and then try to get the company restructured in a way favorable to them. Ideally, they then cash out at twice or three times what they paid. It's not easy. Bankruptcies are acrimonious, legalistic affairs that pit bondholders against other creditors and routinely take two years or more to resolve. Still, Fidelity believes it can enter proceedings as one of the largest bondholders and grab the advantage by using its clout.

HEDGED BETS. The approach worked with Eastern Air Lines. In November, 1990, after Eastern went into Chapter 11, Fidelity started buying the airline's 17 1/4% bonds at about $85 and became the largest holder of the issue. The fund managers felt they could risk getting stiffed, because the bonds were backed by cash and planes. By hiring lawyers and being closely involved in day-to-day negotiations, Fidelity fought Eastern's efforts to grab the collateral, thus protecting it for bondholders. The bonds are now trading at $109.

Fidelity has invested only 15% of the fund's $900 million in distressed securities, such as Hillsborough Holdings and MCorp. The rest is in such top-tier junk as RJR Nabisco. Fidelity hopes to hit a 50-50 mix over the next year. "Our goal is to earn 13% on the high-quality end and 20% on the bankruptcy side," says Dan Harmetz, portfolio co-manager.

So far this year, the fund earned a 10.2% total return, lagging traditional junk-bond funds (table) and the junk market's total return of 13.6%. But it's too early to judge the strategy.

Some investors prefer funds with only high-quality junk. But if you're willing to go out on a limb, Fidelity's way may offer a bigger payoff down the line.

         Total return
      Name                  1990        1991*
      HIGH-YIELD          -40.13%        30.61%
      HIGH-INCOME BOND    -12.80         25.55
      HIGH-YIELD          -18.73         25.36
      & INCOME             -3.84         10.19
      *Through Mar. 28  DATA: MORNINGSTAR INC.
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