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By Jason Stipp | 04-19-2013 02:00 PM

Vaselkiv: Set the Right Expectations for High-Yield Bonds

Favorable fundamentals and better yields relative to other fixed-income assets make high-yield bonds worthy of a long-term allocation, but investors shouldn't try to time the market and must ratchet down their return expectations, say T. Rowe Price High-Yield manager Mark Vaselkiv.

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Jason Stipp: I'm Jason Stipp for Morningstar.

It's the Future of Fixed Income Week on Morningstar.com, and today we are talking about the high-yield market with manager Mark Vaselkiv of T. Rowe Price High-Yield. That's a Silver-rated fund by our Morningstar analysts. He is going to tell us a bit about what he is seeing and what he thinks is the future of the high-yield area of the fixed-income market.

Mark, thanks for calling in.

Mark Vaselkiv: Jason, I look forward to the conversion.

Stipp: Let's talk about the fundamentals of high-yield. What does the financial strength and the default rate of high-yield issuers look right now? What's the fundamental underlying metrics that you are looking at?

Vaselkiv: Most high-yield companies are in very good shape, and we've enjoyed a period over the last five years of significant balance sheet repair from 2008 through the middle of 2013. Most of our companies have been able to obtain new financing and repair balance sheets that were very stressed five years ago, and that has resulted in a default rate that's near the low among historical averages. And we expect that defaults for the next several years will only be about 1% per annum, and that's a very favorable environment to invest in high-yield securities.

Stipp: Do you think that there are potential trouble spots, for example, if rates started to tick up, would that make it difficult for some of these issuers to renew their debt or roll over their debt?

Vaselkiv: No. The good news is that, there is only about $275 billion of bonds maturing in the high-yield market through the end of 2015. So over a 2.5 year period, the maturities have been extended; the largest annual maturity year I think now, is 2021. So, most companies are in pretty good shape and have locked-in low interest rates for a lot of seven-, eight-, and 10-year financing.

Stipp: Let's talk about the yield on high-yield bonds. So the spread levels of high-yield to Treasuries may be within historical norms, or close to historical norms. But the absolute level of yield that you are getting on the high-yield index, for example, is 5% or less than 5%. At that absolute level, do you think that investors are really getting compensated for the risks that they are taking on in high-yield?

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