Not All Junk Stocks Are Garbage

Lower rates could boost high-yield bonds, and that could help shares of the same company

As nasty as 2000 proved for most stock investors, bond investors made money--unless they held high-yield, or "junk," bonds. Talk about nasty. While the average U.S. stock mutual fund returned 0.8% and the average taxable bond fund 5.4%, junk-bond funds last year lost more than 9%, Morningstar reports. Other than technology and foreign stocks, junk proved to be last year's best place to lose money.

Naturally, I expect a reversal of fortune for junk this year. And not just junk bonds. I see stocks in companies whose balance sheets are parlous enough to have sunk below investment grade doing even better if, as the Federal Reserve's urgent moves to ease credit imply, 2001 brings steadily lower lending rates. When junk bonds rise, junk stocks often jump.

But knowing which ones is no cinch for amateur investors. And until now, there haven't been a lot of handy ways to bet on junk stocks. That's why I was intrigued last fall to find Fidelity Investments laying plans for something called Fidelity Leveraged Company Stock Fund (table). Run by veteran Fidelity junk-bond picker David Glancy, the fund opened just before Christmas, even as junk bonds shivered through the worst of a market that's colder even than the recessionary freeze of 1990.

Is this a case of perfect timing? "It's not clear that it is a good time to start," Glancy told me. "It's not clear that it's not"--which clearly means Glancy is a shrewd enough money manager to know what he doesn't know (the economy's future path) and stick to what he does know (company credit analysis).

A STAR. A former Standard & Poor's bond analyst, Glancy joined Fidelity in 1990. Three years later, Fidelity handed him the keys to its main junk-bond fund, Fidelity High Income, which he drove to a No. 1 rank during his tenure. In 1996, he moved to Fidelity Capital & Income Fund, whose portfolio also includes a few stocks. There, over the past five years, he has outpaced 95% of his peers, with a 37.9% return vs. the benchmark index's 24.7%.

Glancy sees Leveraged Company as a mirror image of Capital & Income. The new fund may hold bonds but will be at least 65% in stocks. Fidelity barred him from disclosing which stocks he's buying now, but the Capital & Income fund's portfolio holds clues. Big recent holdings include EchoStar Communications, operator of the satellite-TV Dish Network, and telecom provider Nextel Communications. "There's a smorgasbord of telecommunications/media companies out there that had grand plans and issued lots of debt and lots of equity, too. They used to have $20 billion market caps and now have $2 billion market caps," he said. "We'll have a good shot at picking the ones that will go from $2 billion to $50 billion."

Glancy also has invested in such distressed companies as supermarket chain Pathmark Stores and garbage hauler Allied Waste Industries. Yet he noted that unlike Mutual Shares, which made big money in the 1970s and 1980s by investing in bankruptcies, the fund isn't interested in "the rumps of companies. We're buying real companies that are growing earnings."

Investing this way obviously has its risks. Capital & Income lost 9.4% last year, slightly worse than the average junk fund, in part because of its modest position in junk stocks. Just the same, the last time the junk-bond market lost money--1994, when it dropped a bit more than 1%--it roared back the next year with a 20.5% return, as measured by the Merrill Lynch High Yield Master II Index. The losing year before that--1990, when the index sank 4.4%--was followed by a 1991 rebound of 39.2%. Last year, the index made its worst showing ever, sinking 5.1%.

Is there a necessary reason history will repeat? No. But the odds favor it. In the world of junk, Glancy told me: "It would be difficult not to do well from here over the next 18 to 24 months." I think he's right.

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