Floating Rate Loan Funds (Morningstar)

Five Senior Loan CEFs for Your Radar

Five Senior Loan CEFs for Your Radar
By Cara Scatizzi | 08-13-10

Senior bank loans are typically extended to below-investment-grade companies, which can translate to higher interest-rate payments for banks and investors. After a bank lends the money, it sells the loan as a security to investors and passes the interest payments to investors. Such bank loans are structured to produce yields higher than comparable bonds and also to mitigate certain risks that accompany fixed-income investing.


Senior loans are often short term and have floating interest rates. This reduces interest-rate risk for investors because, as interest rates rise, the short-term floating rates on the loans can be reset quickly to reflect higher rates. Conversely, if interest rates are falling, the floating rates will reset to echo lower rates, which means investors cannot lock in high interest rates with this type of security.


In addition, these loans are secured by cash or assets and are considered "senior." This means that, in the event of bankruptcy, these obligations are the first to be repaid. There is no guarantee of any payment after a default, but because the loans are senior and secured by assets, historically, investors have received $0.75 to $0.80 per dollar in such situations.


Investing in closed-end funds, in general, has many benefits. First, CEFs can use leverage in an effort to enhance performance and distributions. CEFs are also required to distribute income to investors. In addition, CEFs often sell at discounts to net asset value, which means investors can achieve "yield enhancement." Finally, there is an added benefit of diversification. Specific to senior bank loans, CEFs hold hundreds of individual bank loans of varying credit quality and maturity. If one or a few of the companies default on their bank loans, it will most likely have a small effect on the overall portfolio. However, bankruptcy is not the only way for a senior loan to lose value. Deterioration of the individual company's credit can cause a loan to fall in value.


There are 19 senior bank CEFs and only one does not use leverage (the newly created Blackstone/GSO Senior Floating Term Rate (BSL). The remaining CEFs use leverage in the form of debt and preferred shares, which is regulated by the Investment Act of 1940. In addition to senior loans, these types of CEFs also invest in corporate bonds and cash. Ten of the 19 senior loan CEFs trade at a discount to net asset value, which offers investors a yield enhancement via their discount.


Investors seeking the higher income that senior bank loans can offer should be aware of the risks to their underlying capital. The group produced volatile returns in 2008 and 2009, as would be expected given the changes in interest rates, the inherent volatility of leverage, and the turmoil in the credit markets. The average senior loan CEF has gained 0.19% annually over a five-year period, is down 2.97% annually for the latest three-year period, and is up 6.5% in the year to date.

A Closer Look: Five Senior Loan CEFs

Discount /Premium (%)Distribution Rate at Current Price (%)1-Yr Distribution Change (%)Leverage Ratio (%)

Highland Credit Strategies (HCF) -2.1 8.68 0 23.6
Nuveen Senior Income (NSL) +2.4 6.92 19 36.5
Nuveen Fl Rate Inc Opps (JRO) -0.6 6.63 24 36.5
Nuveen Floating Rate Inc (JFR ) -3.9 5.56 24 35.6
LMP Corporate Loan Fund (TLI) -5.8 5.17 20 52.0

The table above lists five senior loan CEFs that, in our opinion, look attractive. Exclusion from the above list does not reflect our dissatisfaction with a fund. Instead, these are the five that have caught our attention at the moment. None of the listed CEFs have decreased distributions in the last year and four of the five have increased the distribution at least once over the last year. In addition, none of them uses return of capital to synthetically boost stated yields.


Highland Credit Strategies (HCF ) has a distribution rate of 8.7%. The fund has not increased the distribution in the last year, but while 13 of the 19 funds in this category decreased distributions, HCF did not. The fund came out of the gates in 2007 and performed poorly, as might have been expected given the credit-market environment at the time. The fund has lost 10.8% per year since inception. However, in early 2009, the fund replaced the portfolio-management team with two new managers, who have outperformed their peer group over the one-year (HCF gained 21.9% versus the peer group's gain of 20.2%) and year-to-date (HCF is up 7.95% versus 6.55% for the peer group) periods. HCF holds 63% in bank loans, with the remainder in low and non-investment-grade corporate bonds and equities. Its largest holding (7.3% of the portfolio) is a holding company for venture healthcare companies. Finally, HCF has a leverage ratio of 23.6%.


Nuveen Senior Income (NSL) is one of three highlighted funds from Nuveen. All three funds are managed by Gunther Stein. NSL is selling at a 2.4% premium to NAV but still offers a 6.9% distribution rate. The fund increased the distribution twice in the last year for a total increase of 19%. In 2009, the fund gained 111% in net asset value (versus the peer group, which gained 76%), during which the fund's share price jumped from a 12% discount to NAV to a 17% premium to NAV in the final four months of 2009. Since inception in 1999, the fund has gained 5.3% annually. 86% of assets are held in bank loans with the remainder in high-yield corporate bonds, convertibles, and cash. The largest sector concentration is media, at 11% of assets. The fund has a 36.5% leverage ratio.


Nuveen Floating Rate Income Opportunities (JRO) has a 6.6% distribution rate and has boosted its distribution twice in the last year for a total increase of 24%. The fund invests 87% of its assets in senior loans and the remainder in junk bonds, cash, and a very small portion in common stock. The current leverage ratio is 36.5%. The fund has performed about as well as the peer group, with the exception of 2009, when the fund outperformed with an impressive NAV gain of 113%. Since inception in 2004, the fund has gained 4.1% annually. Historically, the fund has traded at a discount to NAV (its three-year average discount is 8.04%), but 2010 has proved a volatile year for JRO's premium and discount. In April 2010, the fund shot to at a historically high 9.46% premium, only to drop to a discount of 6.75% in late May. Currently, the fund sells at a slight 0.60% discount to NAV.


Nuveen Floating Rate Income (JFR) has a current distribution rate of 5.6% and is selling at a 3.9% discount to NAV. The fund has increased its distribution twice over the last year for a total increase of 24%. JFR has a current leverage ratio of 36.5%. In 2009, JFR gained 101% and in 2008 the fund lost 50.1%, still slightly beating the peer group. Since inception in 2004 the fund has gained 3.71% annually. JFR holds 86% in bank loans of mostly low credit quality, though 7% of its holdings are bonds rated AAA.


LMP Corporate Loan Fund (TLI) has the lowest distribution rate of the highlighted CEFs, but it is still attractive on an absolute basis. In addition, the fund is selling at the largest discount (5.8%) of the funds listed, making it even more attractive. TLI has increased its distribution twice in the last year for a total increase of 20%. The fund holds 93% in bank loans, with the remainder in corporate bonds and short-term debt. TLI has a relatively high leverage ratio of 52%. Since inception, TLI has gained 4.5% annually. In 2008, when the average senior bond CEF lost 51%, TLI lost 44%.





Cara Scatizzi is a closed-end fund analyst at Morningstar.

States in Trouble: Pension Obligations and Credit Ratings (Barrons)

Barron's Cover | MONDAY, MARCH 15, 2010
The $2 Trillion Hole
By JONATHAN R. LAING | MORE ARTICLES BY AUTHOR

Promised pensions benefits for public-sector employees represent a massive overhang that threatens the financial future of many cities and states.

High Return Junk Stocks - What's Next (Hulbert in NYT)

December 6, 2009
Strategies
When the Performance Looks a Little Too Good
By MARK HULBERT

SANMINA-SCI, the supplier of electronics services, is loaded with debt and in each of the last eightyears has lost money. Its shares have risen more than 600 percent since the stock market rally began on March 9.

Wal-Mart Stores, the discount retailer, has lots of cash on its balance sheet, has very little debt and has consistently turned a profit. Since March 9, its shares have gained just 14 percent.
The disparate treatment meted out to these two companies by the stock market highlights an unusual and, in some ways, worrisome phenomenon: to an extent not seen in decades, shares of companies with weak balance sheets have been soaring, generally outperforming firms with stronger fundamentals.

In part, this is a consequence of the terrible pummeling given to riskier assets of all kinds during the worst months of the financial crisis. Shares of companies that were deemed to be weakest were hit the hardest. It’s only natural that they would bounce back the most at the first hint that financial disaster had been averted.

But the performance gap between the weak and the strong has rarely been as pronounced as it has been since March’s market lows. The extreme outperformance of the more speculative stocks could make them vulnerable to another market shock.
Ford Equity Research, an independent research firm based in San Diego, rates stocks’ financial quality based on a number of factors, including a company’s size, debt level, earnings history and industry stability. All told, Ford Equity follows more than 4,000 stocks. Those in the bottom fifth of its ratings — including Sanmina-SCI — produced an average stock market return of 152 percent from the beginning of March to the end of November, according to an analysis conducted for The New York Times.

The stocks in the highest quintile for quality — including Wal-Mart — produced an average gain of 66 percent over the same period, or roughly 85 percentage points less. That is the biggest disparity over the first nine months of any bull market since 1970, which is the first year for which Ford Equity has quality ratings.

Historical comparisons to bull markets prior to 1970 must rely on a proxy for financial quality, and perhaps the best available is market capitalization. Not all large-cap companies are financially healthy, of course, and not all small caps are weak. But, historically, as a group, the difference between the large- and small-cap sectors has proved to be roughly correlated with the disparity between high- and low-quality stocks.

Since the March lows, for example, according to Ford Equity, the 20 percent of stocks with smallest market capitalizations have on average outperformed the largest 20 percent by 72 percentage points — only slightly less than the 85-point disparity between the lowest- and highest-quality issues.

By contrast, in the first nine months of all bull markets since 1926, the average outperformance of the small-cap sector was just 21 percentage points, or less than one-third as much as the disparity over the last nine months, according to calculations by The Hulbert Financial Digest.

Only once since 1926 have the first nine months of a bull market produced a gap greater than this year’s. That was in the bull market that began in February 1933, in the middle of the Great Depression, when small caps outperformed large caps by an incredible 196 percentage points.

How can we explain the current extreme performance disparity? The federal government’s stimulus program is the main cause, in the view of Jeremy Grantham, the chief investment strategist at GMO, a money-management firm based in Boston. Mr. Grantham said in an interview that by temporarily reducing the danger of incurring risk, the government had effectively encouraged huge amounts of risk-taking in financial markets. “The sizable disparity of junk over quality should not have come as a big surprise,” he said, “given how massive the government’s stimulus has been.”

As an unintended consequence, Mr. Grantham said, high-quality stocks today are about as cheap as they have ever been relative to shares of firms with weaker finances.

“It’s almost a certain bet that high-quality blue chips will outperform lower-quality stocks over the longer term,” he said.

Mark Hulbert is editor of The Hulbert Financial Digest, a service of MarketWatch. E-mail: strategy@nytimes.com.

Latest Downgrades to Junk - Fallen Angels (Bloomberg, WSJ)

‘Fallen Angels’ Jump to Third-Highest Monthly Total, S&P Says


By Megan Johnston

July 13 (Bloomberg) -- Fifteen companies lost their investment-grade ratings in June, the third-highest monthly tally since 1987, according to Standard & Poor’s. With rankings for two additional issuers cut to junk status, the number of “fallen angels” climbed to 60 this year with a combined debt of $209.2 billion, S&P analysts led by Diane Vazza in New York said in a report today.

The tally of borrowers downgraded last month to junk, or below BBB-, ranks behind the 19 issuers cut to junk during the Asian financial crisis in December 1997 and the 17 whose credit ratings were reduced in March, S&P said.

The largest fallen angel this year is CIT Group Inc., the New York-based commercial lender that has been unable to persuade the government to back its bond sales, with $38.2 billion in rated debt, S&P said.

Moody’s Investors Service slashed CIT’s credit rating four levels to B3, from Ba2, and said the ranking may be cut further because of the company’s “inadequate progress” toward improving its liquidity, according to a statement today.

An additional 75 issuers with combined debt of $255.2 billion are at risk of losing their investment-grade ratings, S&P said.

“Not surprisingly, many of the sectors represented on the potential fallen angel list -- such as consumer products, forest products and building materials -- show a high preponderance of negative bias,” the S&P analysts said in the report.

To contact the reporter on this story: Megan Johnston in New York at mjohnston17@bloomberg.net

Last Updated: July 13, 2009 14:12 EDT



Standard & Poor's said the number of issuers downgraded to speculative grade last month was the third highest monthly tally since it started keeping track of the figure in 1987.

Fifteen entities were cut to junk territory in June, and with two more added so far this month, the year-to-date tally has jumped to 60 issuers, with rated debt of $209.17 billion affected.

Finance companies lead this year's so-called fallen angels with 10 so far, followed by banks at nine and utilities with six.

S&P said 75 issuers currently exhibit fallen-angel potential - entities rated BBB- either on watch for downgrade or with a negative ratings outlook. Those firms have $255.22 billion of rated debt. Banks still lead the list of companies vulnerable to being cut to junk, with 15 companies, followed by consumer products and insurance with eight apiece and utilities at six.

Struggling U.S. commercial lender CIT Group Inc. (CIT), which could soon file for bankruptcy protection, tops the list as the largest fallen angel so far this year based on debt volume, with $38.19 billion in rated debt.

Besides CIT, other new fallen angels include insurance holding company Ambac Financial Group Inc. (ABK), French auto maker Renault SA (RNO.FR) and U.S.-based bank holding company Whitney Holding Corp. (WTNY).

The Republic of Hungary is the largest potential fallen angel this month, S&P said, with $53.99 billion in rated debt.

-By Kerry Grace Benn, Dow Jones Newswires; 212-416-2353; kerry.benn@dowjones.com

CNN: GM not paying June 1 interest

GM won't make $1B June debt payment

June payment would be due a day after government's deadline for company to submit restructuring or bankruptcy plan.

By Peter Valdes-Dapena, CNNMoney.com senior writer
April 22, 2009: 1:10 PM ET

NEW YORK (CNNMoney.com) -- General Motors won't be making a June 1 debt payment of $1 billion, a company spokeswoman said Wednesday.

The debt is due the day after GM's government-imposed May 30 deadline to have an aggressive restructuring plan in place or be left to face bankruptcy.

GM (GM, Fortune 500) said it wouldn't make the June 1 payment because as part of its restructuring, the company will be offering to exchange bondholder's debt for equity in the company.
"We're going to have an exchange offer open anyway," said GM spokeswoman Julie Gibson.

A press representative for GM bondholders was not immediately available to comment.

While GM CEO Fritz Henderson has said that bankruptcy has become "more likely" in recent weeks, he has also said that an out-of-court restructuring remains a viable option.

GM has received $13.4 billion in federal loans and could receive an additional $5 billion before May 30. Beyond that, the Treasury department task force overseeing restructuring for GM and Chrysler has not said how much more support GM might be eligible to receive if it is able to restructure and reduce its debts and other obligations.








Find this article at:
http://money.cnn.com/2009/04/22/autos/gm_june_debt

Moody's List Companies at Risk of Default (WSJ )

March 9, 2009
The 'Bottom Rung' -- Companies at Greatest Risk of Defaulting

Moody's Investors Service is launching a list called the "Bottom Rung," which details 283 companies that are at risk of defaulting on their debt. Below are the 30 largest companies on the list, based on rated debt.



Allison Transmission, Inc. B3 B3 Negative 4.60 Automotive: Parts
AMR Corp. Caa1 Caa1 Negative 1.62 Transportation Services: Airline
Building Materials Corporation of America Caa1 B3 Negative 1.55 Manufacturing: Finished Products
Chrysler LLC Ca Ca Negative 9.00 Automotive: Passenger
Citadel Broadcasting Corp. Caa3 Caa2 Negative 2.29 Media: Broadcast Tv & Radio Stations
Claire's Stores, Inc. Caa3 Caa3 Negative 2.59 Retail: Department Stores
Dana Holding Corp. Caa1 Caa1 Rating under reveiw 2.08 Automotive: Parts
Dole Food Company, Inc. Caa1 B3 Negative 1.51 Natural Products Processor: Agriculture
Eastman Kodak Co. B3 B3 Negative 2.10 Technology: Hardware
Ford Motor Co. Caa3 Caa3 Negative 31.55 Automotive: Passenger
Freescale Semiconductor, Inc. Ca Caa1 Negative 10.20 Technology: Semiconductor
General Motors Corp. Ca Ca Negative 38.56 Automotive: Passenger
Georgia Gulf Corp. Caa2 Caa2 Negative 1.98 Chemicals: Commodity Chemical
Hawker Beechcraft Acquisition Co. B3 B3 Negative 2.85 Aircraft & Aerospace: Equipment
Idearc, Inc. Caa3 Caa2 Negative 9.29 Media Publishing: Books
Lear Corp. Caa2 Caa2 Rating under reveiw 2.30 Automotive: Parts
Level 3 Communications, Inc. Caa1 Caa1 Rating under reveiw 1.87 Telecommunications: Wireline
Michaels Stores, Inc. B3 B3 Negative 3.93 Retail: Specialty
OSI Restaurant Partners, Inc. Ca Caa1 Rating under reveiw 2.11 Restaurants: Family Dining
R.H. Donnelley Corp. Caa2 Caa1 Negative 3.48 Media: Printing - Holdco
Reader's Digest Association, Inc. Caa3 Caa3 Negative 2.21 Media Publishing: Newspapers & Magazines
Realogy Corp. Caa3 Caa3 Negative 7.56 Services: Consumer
Rite Aid Corp. Caa2 Caa2 Negative 6.80 Retail: Drug Stores
Source Interlink Companies Inc. Caa1 Caa1 Negative 1.63 Media Publishing: Newspapers & Magazines
Swift Transportation Co., Inc. Caa1 Caa1 Negative 2.98 Transportation Services: Trucking
Tenneco Inc. B3 B3 Negative 1.83 Automotive: Parts
Univision Communications, Inc. B3 B3 Negative 10.09 Media: Diversified Media - Fc
US Airways Group, Inc. Caa1 Caa1 Negative 1.60 Transportation Services: Airline
Visteon Corp. Caa1 Caa2 Negative 3.20 Automotive: Parts
Western Refining, Inc. B3 B3 Negative 1.40 Energy: Oil - Refining & Marketing

Sources: Moody's Investors Service

from Barrons: Bonds are Back

Monday, April 21, 2008


FEATURES MAIN




Bonds Are Back in the Game
By ANDREW BARY

FOR THE FIRST TIME SINCE THE credit scare of 2002, most taxable bonds offer a compelling alternative to stocks.

With the stock market's rebound tentative at best, and money-market mutual funds paying just 2%, down from 5% a year ago, that's good news for yield-hungry individual investors. Junk bonds, convertible securities and mortgage-backed debt provide attractive yields with varying amounts of appreciation potential, and all fit particularly well in tax-deferred accounts like IRAs.


High-yield, or junk, debt, now yielding an average of more than 10%, could generate 15%-plus returns in the next 12 months if the economy bottoms later in 2008, while equity-sensitive convertibles could rise 20% or more. The convertible market has seen heavy new issuance lately as financial companies, including Citigroup (ticker: C), Bank of America (BAC) and Wachovia (WB), have sought to bolster their depleted capital by selling billions of dollars of convertible-preferred stock. These NYSE-listed issues are yielding 6% to 7%, some of them more than the common shares.

Mortgage securities issued by the three government-sponsored agencies, Ginnie Mae, Freddie Mac (FRE) and Fannie Mae (FNM), now yield about 5.5%, and could show high single-digit returns in the next year. Depressed non-agency securities backed by prime and so-called Alt-A loans could produce mid-teens returns.

The safest market is the most unappealing: U.S. Treasuries. With Treasury yields ranging from 2.2% on a two-year note to 4.6% on a 30-year bond, investors are getting negative real yields after taxes and inflation, now running at 4%. Given low Treasury yields, its possible total returns (yield plus bond-price change) could be negative in the next year.




Junky No More: Junk bonds now yield nearly eight percentage points above Treasuries, while investment-grade bonds yield three points more.
Barron's Roundtable member Bill Gross recently called Treasuries "the most overvalued asset in the world, bar none." In a CNBC interview, Gross, who manages the country's largest bond fund, Pimco Total Return1 (PTTRX), added that Treasury yields "don't make any sense relative to inflationary expectations down the road." Pimco Total Return has been tilting away from Treasuries and into mortgage securities, which Gross says "represent some of the most compelling values" in the bond market.

Larry Fink, the chief executive of BlackRock, a big bond manager, said on the company's earnings conference call last week that he has been telling clients "it is time to take more risk, and...start looking to move away from Treasury-oriented strategies to more credit-oriented and mortgage-oriented strategies."

Municipal bonds look appealing relative to Treasuries, but their absolute yields aren't great. The muni market has rallied in the past month with yields on top-rated long-term issues now in the 4.5% to 4.75% range, down from a peak of 5.5% or more. Munis yield more than Treasuries, which is rare because of the tax benefits of munis, but Treasury yields are extremely low. A five-year muni yielding 3.25% might look good relative to a Treasury at 3%, but even a tax-free 3.25% yield doesn't look great relative to inflation.

THERE ARE MANY WAYS TO INVEST in the bond market, including individual debt issues, open-ended mutual funds, closed-end funds and, more recently, exchange-traded funds. In the tables on the next page, we've listed a range of attractive bond-investment choices, including mutual funds and individual convertible and junk issues. Mutual funds are a particularly good idea for mortgage securities, given the hassle of trading individual mortgage issues and the difficulty of reinvesting periodic principal payments.

The direction of the U.S. economy, the global financial backdrop and the health of the housing market will be critical to bond returns over the next year. Treasuries and, to a lesser extent, munis would be helped by a weak economy, while most other sectors would be hurt.

Here's a closer look at the individual market sectors:

Junk

Many junk-bond mavens agree the market looks enticing, with the average issue yielding 10.5%, and bonds from distressed concerns like Charter Communications, Tribune and Realogy yielding more than 20%. The issue is timing. Some investors think the market will get worse before it gets better, particularly if the economy sputters for the rest of '08 and defaults spike, as expected.

"This is about the only cycle when spreads have widened so much before a rise in defaults," says Marty Fridson, chief executive of FridsonVision, in New York.


"It might be a little early. Our sense is that the economy will remain weak for the next three to six months and corporate earnings will be ugly," says Mark Vaselkiv, manager of the T. Rowe Price High-Yield Fund2 (PRHYX). Vaselkiv says the high-yield spread above Treasuries, now about 7.75 percentage points, could top 8 percentage points again later this year. The spread hit 8.5 points in March and was as wide as 10 points in 2002. Last spring, it stood at just 2.5 points.

While the $1 trillion junk market could hit another rough patch later this year, Vaselkiv finds plenty of bonds to buy, including those of General Motors Acceptance Corp., Sprint and Harrah's Entertainment. GMAC has been hurt by losses at its mortgage unit, but its core auto-finance business still is reasonably healthy.

"Senior management continues to emphasize it will capitalize GMAC appropriately, and there's no way GM survives without GMAC," Vaselkiv says. GMAC's one-year debt now yields 11%, while long-term issues, like the NYSE-listed 7.25% bond due in 2033 (ticker: GKM), yields 11.50%. This issue has a face value of $25 and trades around 16, or about 64 cents on the dollar. Most corporate bonds are sold with a face value of $1,000.

SPRINT APPEALS TO VASELKIV because its debt yields about 9.5%, yet it still has investment-grade credit ratings. Sprint's profits have disappointed and the company has been losing market share. Wall Street worries about Sprint's $22 billion of debt, but the company's ratio of debt to annual cash flow is around 3, versus a ratio of 10 for heavily leveraged companies. And, Sprint (S) still has a stock-market value of $20 billion.

Berkshire Hathaway CEO Warren Buffett also has been attracted to the junk market, buying debt issued by TXU, the Texas utility that was subject of an $43 billion leveraged buyout last year. TXU bonds, like the 10.25% issue due 2015, yield a shade under 10%. It's a good bet Berkshire bought more junk in the first quarter.

Harrah's went private in a $27 billion LBO earlier this year, just as the supposedly recession-proof casino industry hit a downturn. Reflecting concerns about Harrah's debt load, the company's senior unsecured bonds, like the 10.75% bonds due in 2016, trade for 84 cents on the dollar and yield 14%. The junior debt yields as much as 20%.




While junk funds generally have had negative returns in the low single digits in the past year, the situation could change in the next 12 months given high yields and depressed prices throughout the market.

The yield gap of high-grade bonds relative to U.S. Treasuries also has gotten wide, hitting 3 percentage points in late March, compared with less than a point a year ago, according to Merrill Lynch.

Reflecting this trend, GE Capital, which has a triple-A credit rating, last week issued 10-year debt at 5.66% and 30-year bonds at 6.45%, both about two points more than Treasuries. Intermediate-term debt from the major brokers yields 5% to 6%. With the Federal Reserve essentially throwing a safety net under the brokerage industry, it's unlikely companies like Lehman Brothers (LEH), Merrill Lynch (MER) and Morgan Stanley (MS) will default on their bonds.

Convertible Bonds

Convertibles combine two attributes: bond yields and the appreciation potential of stocks. Investors eyeing the depressed financial sector have plenty of convertible choices because Citigroup, Lehman Brothers, Bank of America, Wachovia, Washington Mutual (WM), MGIC (MTG) and SLM (SLM) all have tapped the market this year. "Boomlets in issuance often coincide with a sector that has gotten cheap," says David King, manager of the Putnam Convertible Income Growth Fund3 (PCONX) and the closed-end Putnam High-Income Securities Fund (PCF). King, a long-time convertible investor, has bought the Citigroup, Bank of America, Wachovia and Lehman issues.

The new convertible preferred issues generally yield 6% to 7%, offer more secure dividends than common shares, and, quite important, give investors plenty of time to benefit from stock appreciation thanks to five years of call protection. Some converts, like the Citigroup issue, were sold originally at $50 a share, while others, like the Bank of America and Wachovia deals, have a face value of $1,000.

Financial companies also have been issuing tens of billions of dollars of fixed-rate nonconvertible preferred stock this year. The converts probably are a better deal, as the straight preferred issues yield around 8% but have limited upside potential. It's a different story with converts. If the underlying stocks gain 25% over the next year, converts could rally 10% to 15%, producing total returns of around 20%.




The Fidelity Convertible Securities Fund4 (FCVSX) has increased its exposure to financials lately from a near-zero weighting. The fund, managed by Tom Soviero, has scored with investments in commodities and energy, including Freeport McMoRan Copper and Gold (FCX). It's up 15% a year in the past three years, almost double the average return on convert funds.

General Motors (GM) and Ford Motor (F) converts are excellent alternatives to the companies' common shares because they're debt, not preferred, and thus have added security. GM has issued a series of converts, including the 6.25% issue (GPM) that trades near 17, below its face value of 25. It can be redeemed at the holder's option in 2018 at 25, resulting in an 11.9% yield. Given the low price, downside risk may be limited, short of a GM bankruptcy. If GM stock doubles from its current price of 20, the convert could be up 50%. The GM converts look good relative to the common shares and the company's nonconvertible debt, which yields 11% to 12%.

Mortgage Securities

Investors can play it safe and purchase funds like the low-fee Vanguard GNMA5 (VFIIX), which has more than 95% of its assets in government-backed Ginnie Maes, or take a little more risk with funds like the TCW Total Return Bond6 (TGLMX).

Given the complexity of mortgage issues, it pays to stick with managers who have demonstrated they understand that market. The managers of the TCW fund, Jeff Gundlach and Phil Barach, have been together more than 20 years and have put together a strong record for institutional and retail investors.

Their $1.4 billion fund has added significantly to its non-agency mortgage debt in recent months because prices got as low as 60 cents on the dollar. Gundlach says these issues carry current yields of 8% and could generate annual total returns well above 10%. Gundlach sticks with the top-rated tranches of prime and Alt-A mortgage securities. The closed-end TCW Strategic Income Fund (TSI) has about half its assets in mortgage securities. It trades at about $3.70 a share, a 13% discount to its net asset value.

The giant Pimco Total Return fund, with $127 billion in assets, roams the world in search of opportunity. It now has almost two-thirds of its assets in mortgage securities, and has bested its major rivals and its benchmark, the Lehman U.S. Aggregate bond index, in the past year, with a total return of 11%. TCW Total Return is up about 6%.

Municipal Bonds

Given strong gains in recent weeks, munis have become less appealing. Open-ended long-term muni funds are yielding about 4%, while closed-end funds can yield 5% or more.

The Legg Mason Partners Managed Municipals7 fund (SHMMX), run by veterans Joe Deane and Dave Fare, has a great long-term record. It also has done well in the past year, rising 5%, about four points better than the average long-term muni fund. The fund was defensively positioned for much of 2007 but grew more aggressive after munis tanked earlier this year.

FINANCIAL PLANNERS AND BROKERS typically advise investors to put some of their money in bonds. Now is a good time to diversify, given ample yields in many sectors of the market.


--------------------------------------------------------------------------------

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