WHY WE LOVE HIGH-YIELD CORPORATE BOND FUNDS:

Transcription

1 WHY WE LOVE HIGH-YIELD CORPORATE BOND FUNDS: Most Ocean Park clients have a managed High Yield Corporate Bond (HYCB) fund for two good reasons: (1) The asset class has proven productive over time, and (2) Ocean Park s Defensive Timing has kept them out of trouble during market declines. The following information tells a little more about the asset class and why we and your Financial Advisor have recommended a managed HYCB account at Ocean Park. If you haven t opened a monitored HYCB fund account, we hope you ll do so after reviewing these low volatility, conservative investment strategies. HYCB Funds Have Long-Term Returns Disproportionately Higher Than Their Risk: High-Yield Corporate Bonds (HYCB s) are IOU s of companies who are too new or too debtheavy to qualify for investment grade ratings (AAA, AA, A or BBB from Standard and Poor s, for example). In effect, investment-grade bonds are judged to have a low risk of default (inability to pay each installment of interest when due), whereas HYCB s are judged to be more risky as to the potential for future default hence the term junk bonds. As a result of this characterization, HYCB issuers must pay a higher interest rate (thus, high yield ), to compensate bondholders for the higher perceived risk of default. The difference in yield (interest rate) paid on HYCB s compared to Treasury bonds with the same due date is called the HYCB yield spread. Over the past ten years the yield on HYCB s has averaged about 10%, while the yield on comparable Treasuries (which have zero default risk) has averaged about 6%. So HYCB bondholders are being paid about 4% per year, on average, in extra interest to compensate them for the perceived risk of default. Over the past 50 years, however, HYCB s have always substantially over-compensated for the actual impact of defaults. And by diversifying a HYCB portfolio among different bond issuers, a large portfolio manager can assure that the portfolio as a whole will not suffer significantly if one company defaults without warning. HYCB funds pay very generous dividend yields for every month you are in these funds. Because these high yields overcompensate for default impact, HYCB funds have a long-term history of providing much better returns than CD s, Treasuries or money-markets funds (see table comparing average annual returns on final page).

2 Some HYCB Fund Managers Add Extra Value: The HYCB arena is one where a skillful portfolio manager can really add value, in two ways: First, finding the gold among the dross bonds of companies whose fundamentals are likely to improve, resulting in an upgrade in rating and an increase in bond value. Second, after buying each high yield corporate bond, a skillful manager keeps close track of the issuing company, dumping the bond quickly from the fund if any sign of deterioration occurs. Out of over 100 HYCB mutual funds, your Financial Advisor selects those managers whose quarterly results provide evidence of skill the ability to deliver better returns than the average manager most of the time, without extra volatility. The HYCB fund managers selected by your Financial Advisor have experienced an actual default impact of less than 1% per year on average -- while collecting a yield spread averaging over 4% per year to compensate for defaults. This is a good deal! Why Timing Works for HYCB Funds: HYCB mutual funds are notoriously easy to time. Not only are they less volatile than stock funds, they are actually less volatile than Treasury bond funds. Over the past fifty years, there have been about twenty significant declining episodes in the HYCB sector. But because the HYCB sector always changes direction rather slowly (see Northeast Investors Trust graph below), each significant decline starts out as a mild decline giving a professional timer plenty of opportunity to react (to duck temporarily into money-market) before the HYCB decline becomes painful.

3 This Queen Mary turning radius which characterizes the HYCB sector is why Ocean Park s HYCB timing technique has always allowed us to move 100% into money-market before the fund is off its high by more than 3% -- and sometimes we are out less than 1.5% off the high day. For the HYCB portion of your Ocean Park account your downside risk is never greater than 3% -- true even during the 1987 global crash. In other words, because of Ocean Park s daily monitoring and Defensive Timing SM, 97% of your HYCB fund assets is unaffected by market risk downward swings due to global crisis, economic problems, etc. Not every Ocean Park sell signal is productive some turn out to be false alarms but every single one protects your account from any adverse impact should the initial mild decline continue or worsen. Thus, our sell discipline serves as a rather close safety net, limiting your downside risk at all times, and delivering peace of mind so that you will remain comfortable having a portion of your investment assets participate in this productive asset class for many years. In 1998, most HYCB funds ended the year with a loss, whereas Ocean Park s Defensive Timing side-stepped most of the 14% decline (see graph) and resulted in a profit of about 8% for the year. Look back at the HYCB table (see reversed side of this page) and compare other unproductive buy-and-hold years for Kemper High Yield with the timed result for those years. Then study the average annual return for the different columns to see how Defensive Timing can enhance returns over the long term. On those occasions when the HYCB market makes a big decline (as in 1998, see graph), we buy back in at prices significantly lower than we sold, so that you end up owning more fund shares than the buy-and-hold investor. Although these opportunities to enhance return through timing do not occur every year, over the longer term they result in higher returns than the buy-and-hold approach. Let your Financial Advisor know if you d like more details on Ocean Park s timing of HYCB funds or our High Yield Corporate Bond Program.

4 HIGH YIELD CORPORATE BOND PROGRAM OCEAN PARK ASSET MANAGEMENT Many investors have investment goals including risk constraints that tend to limit their choices to Certificates of Deposit, Treasuries, money-market accounts and muni bonds, which in recent years have not been very productive (see first column in the table below). Yet far better returns are available in diversified, skillfully-managed bond funds such as Kemper (now DWS) High Yield. Ocean Park s HYCB Program offers a professionally-selected portfolio of four of the best-performing bond funds, with proven riskmanagement disciplines. Even though Kemper (now DWS) High Yield was a top choice for many years, now there are over 100 High-Yield Corporate Bonds funds to choose from. As you can see from the final column in the table below, Ocean Park s recent HYCB fund choices with our daily monitoring and sell discipline offer an excellent approach for the conservative investor. DWS FRANKLIN DWS DWS HIGH INCOME HYCB YEAR MONEY MARKET U.S. GOV T SECS HIGH INCOME WITH TIMING** PROGRAM*** % -1.0% 0.1% 2.2% % 0.4% 2.4% 11.4% % -12.6% -0.9% 17.7% % 6.7% 8.7% 21.5% % 33.3% 39.5% 38.0% % 9.3% 17.7% 20.2% % 12.9% 10.2% 13.8% % 19.9% 23.1% 21.4% % 10.5% 18.3% 14.7% % 4.3% 9.0% 11.5% % 7.3% 14.4% 12.1% % 12.7% -1.1% 1.5% % 10.3% -13.0% 9.5% % 14.0% 46.8% 38.0% % 7.3% 17.1% 14.5% % 6.9% 20.3% 17.9% % -2.7% -1.7% -1.3% % 16.7% 17.5% 15.1% 15.1% % 4.6% 13.5% 10.4% 13.2% % 9.5% 11.5% 9.4% 13.5% % 6.6% 1.3% 8.9% 8.0% % 0.8% 2.4% 2.8% 7.2% % 10.6% -9.2% -2.1% 2.9% % 7.7% 3.6% 1.3% 0.9% % 8.6% -1.0% 4.5% 9.6% % 1.8% 25.0% 21.3% 29.2% % 3.8% 12.3% 10.7% 4.7% % 2.8% 4.0% 3.1% 2.9% % 3.7% 10.3% 8.1% 9.5% % 6.4% 1.0% 2.2% 3.3% % 6.9% -23.7% 2.4% 0.7% % 4.8% 41.6% 39.7% 32.5% LATEST 32 YRS CRR* 549.4% 790.4% % % N/A 6.0% 7.1% 9.1% 12.1% N/A * Compounded Rate of Return: The equivalent smooth rate which would compound to the same final gain. ** After fees. Periods prior to 3/86 are hypothetical (backtested). *** Diversified portfolio of four or more selected HYCB funds, after timing and fees. Periods prior to 7/98 are hypothetical (backtested): although some HYCB funds used by Ocean Park in actual accounts had comparable results, Ocean Park did not have any acutual managed accounts using this particular portfolio until 7/98. See Cautions on reverse.

5 Cautions and Limitations While USFT believes that our investment strategy in general and our Defensive Timing discipline in particular can reduce the impact of sustained market declines and provide other benefits over periods of 18 months or more, there will be intervals when any given timing system will underperform a buy-and-hold strategy. Past performance of a particular fund or timing system, such as those used by USFT, is no guarantee of future performance, particularly over periods shorter than 18 months. Periods prior to 7/98 are hypothetical (backtested): although some HYCB funds used by USFT in actual accounts had comparable results, USFT did not have any actual managed accounts using this particular portfolio until 7/98. The hypothetical data for the period prior to 7/98 represent actual results for some HYCB funds, with USFT's timing, and hypothetical (backtested) results for other HYCB funds, using the same timing formula. The funds used for the backtesting were those selected in June 1998 to be used in the HYCB Program as of then, since there is no clear way to know which HYCB funds USFT would have chosen in those prior years; and in fact USFT "upgraded" some of the fund choices when actual accounts were started in July Such upgrades are made from time to time in actual accounts when a fund changes managers or its performance otherwise begins to lag the peer group. Cautions regarding backtested (hypothetical) performance: A portion of the attached performance data is backtested (hypothetical), so please note the following cautions (based on SEC requirements): (a) Performance does not represent actual account performance, and should not be interpreted as an indication of such performance. (b) There is no assurance that these backtested results could, or would, have been achieved by USFT had it been in business during the years presented. (c) The backtested portion of the performance data does not represent the impact that material economic and market factors might have on an investment advisor's decision-making if the advisor were actually managing clients' money. (d) The SEC mandates that we state: The investment strategy that the backtested results were based upon can (theoretically) be changed at any time with the benefit of hindsight in order to show better backtested performance, and (theoretically) the strategy can continue to be tested and adjusted until the desired results are achieved. Please note that at USFT, no such "data fitting" adjustments have in fact been made. Other information: Performance for the first three columns comes from the fund companies and/or industry sources such as Morningstar. Performance for the last two columns (except as noted above as to backtested periods) comes from actual managed accounts at USFT or its predecessor California Fund Timing Service either by selecting an account which we believe to reflect typical results (a "marker account") for that period, or by averaging all actual accounts in the Program. All performance results are presented on a Total Return basis, that is, assuming the reinvestment of fund dividends and other distributions. Results in your account, of course, will be impacted if you add or withdraw significant amounts during a given period.