The Glories and Dangers of junk

ALL that glitters on Wall Street is not gold, but it may be junk junk bonds. These are bonds that are rated low by the official bond rating services: BB+ or lower by Standard & Poor's, BAI or lower by Moody's. As a trade off for their risk, junks pay higher yields than do top quality bonds, and often sell at a discount. In mid 1989 junks were yielding between 12% and 14%, compared with 9.67% for long term industrial AAA issues.

You can lessen your chances of choosing a bond that may default if you diversify, by buying a bond mutual fund. Look for a fund that in its name has the term "high yield" that means junk. Along with the yields, junks offer you a better chance for capital gains than do high rated issues. When interest rates drop, or bond ratings are upgraded, the prices of junk bonds often shoot up faster than do better quality issues.

When you shop for junk, you should distinguish between two types: genuine trash and quality junk. Some bonds may be diamonds in the rough. The companies that issue the bonds may be simply too young to have a long and favorable credit history. In other cases, the ratings services may not yet have recognized turnarounds in the issuing companies. And still other bonds may be quality junk because they are found in out of favor lines of business, such as gambling. So you may do well by scouting for glitter amid the junk.

Recently a new and far riskier type of trashy junk bond has been flooding the market. Many of these new debt issues are being used to finance corporate takeovers by outsiders or so called leveraged buyouts by company insiders. Either way, many corporations are overburdened with more debt than they safely can support.

If there is a recession or a miscalculation by the dealmakers, some of these corporations could take a dive and drag bondholders down with them. In a major bankruptcy, a defaulting junk bond could lose more than half its value overnight.

To be on the safe side, avoid junk bonds issued in connection with such takeovers and buyouts. Some of' them may be sound, but it's almost impossible for amateurs to evaluate. Also, diversify your holdings to reduce your risk. The best way is to invest in a corporate bond mutual fund that actively manages 70 to 140 issues. High yield bond funds in mid 1989 were returning about 8.4%. The following bond funds have had the best results during the past five years: Eaton Vance Income Fund, 112.6%; Kemper High Yield Fund, 11.6% and Delaware Group Delchester 1, 108.2%.