Sep 23, 2015

When oil prices collapsed late last year, the $83 billion dollar FranklinTempleton Income Fund suffered mightily, losing more than $2 billion dollars on its energy-company investments according to the Wall Street Journal. Portfolio manager Ed Perks responded as portfolio managers at Franklin Templeton often do: He doubled down, purchasing $2 billion dollars more of energy-sector junk bonds. So far, the trade is a bust. Stock and bond prices declined further this summer as oil dropped. In August, fund investors pulled out about $1.47 billion dollars worth--the biggest departure in the fund’s 67-year history except for October 2008.

But Franklin Templeton isn't the only major bond fund holding junk. Vanguard, Loomis Sayles, Blackrock, and Lord Abbott all have added junk to their portfolios to bump up the stated yield. Here's the problem according to the Wall Street Journal--when rates rise and mass redemptions come in, these funds are forced to sell their most liquid high quality assets first, in order to raise cash. You may be thinking long term but the other investors are thinking "exit door" leaving you with a lower quality holding. In segments 2 and 3 today, Steve and Sinclair review insights from leading analysts and draw conclusions.