Playing the Increase In Junk Bond Yields

I started a small position in the Morgan Stanley High Yield Fund (MSY – $5.76) today. According to the Closed-End Fund Association website, the Morgan Stanley closed-end fund is trading at at 14% discount to Net Asset Value of $6.72. The recent increase in junk bond yields (drop in prices) has made me neutral on the sector (from negative).

MSY analysis:

1. Junk bond (non-investment grade) yield spread have increased lately, meaning investors get paid more for taking additional risk.
2. MS High Yield fund is at a big discount. I’m buying the underlying bonds at a 14% off to what it would cost to buy them directly. Now there is no guarantee this discount will close, but a 15% discount does tend to set a floor for this fund.
3. Yield of 7.5%

1. Rising defaults on junk bonds could hurt this fund.
2. Potential for rising interest rates.
3. The huge expense ratio 2.00% charged by Morgan Stanley Asset Management for managing this fund should keep the discount to NAV from improving all the way to zero.

Disclosure: I own MSY as described above. I may buy more in the near future, depending on prices and market conditions. I may also sell this fund and switch to Indexed Exchange Traded Fund that specializes in junk bonds like (HYG – $104.39) if the discount to NAV closes significantly.

I have been previously employed as a Managing Director at Morgan Stanley. I worked in the equity trading division and did not deal with Morgan Stanley Asset Management. I am still vested in their pension and executive compensation plans. I own Morgan Stanley (MS) stock.

Junk Bonds
Photo:L.x. Fringe, Creative Commons, Flickr