July 2009

Investing in high-yield bonds is like landing a fighter jet on an aircraft carrier. During a storm. At night.

“It’s high risk with the potential for high reward,” says Richard Inzunza, portfolio manager of the Northern High Yield Fixed Income Fund.

After crashing last year, high-yield bond prices soared this spring as hints of an economic recovery fueled a powerful rally.

Troubleshooter
The high-yield subset of the domestic bond market consists of issues rated below investment grade. That’s a broad category, ranging from BB to C credits.

“These are vulnerable companies,” says Inzunza, “so we look closely at the credit-worthiness of the issuer and the economic circumstances in which they compete.”

That combination of bottom-up and top-down analysis paid dividends — literally — for Fund shareholders during the recent financial crisis.

In October 2007, Inzunza and his team of nine research analysts were troubled by a Federal Reserve statement that said inflation was a greater risk than slowing growth. “We didn’t agree, so we shifted the Fund into a defensive configuration,” he says.

Good move. The U.S. economy was headed for the worst financial crisis since the Depression. By May 2009, roughly 10% of high-yield bonds had defaulted over the previous 12 months.

Despite the treacherous environment, the Northern High Yield Fixed Income Fund didn’t have a single default during that period.

“Zero,” says Inzunza. “We don’t make guarantees, but we haven’t suffered even one default in three years.” Hoping to keep that streak alive, Inzunza says he has been striving to find the best values among BB-rated paper, the highest-quality sector of the high-yield group.

Spreading risk
Inzunza assembles a roughly 100-bond portfolio that’s big enough to offer broad diversification yet small enough to allow for exhaustive credit analysis.

“The key to investing in high yield is to do your homework,” he says. “We won’t buy a bad credit just because it carries a high potential yield. Our goal is keep the income we earn.”

Judging from his recent results, consider it mission accomplished.

Past performance is no guarantee of future performance.

Diversification does not guarantee a profit nor protect against a loss.

Bond Risk: Bond funds will tend to experience smaller fluctuations in value than stock funds. However, investors in any bond fund should anticipate fluctuations in price, especially for longer-term issues and in environments of rising interest rates.

High Yield Risk: Although a high yield fund’s yield may be higher than that of fixed income funds that purchase higher-rated securities, the potentially higher yield is a function of the greater risk that a high yield fund’s share price will decline.