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Were no different during this time. if you refer to the chart, "historic spreads & performance", notice that spreads, for the most part, moved higher from 1998 through mid 2002. in that time, highyield bonds returned under 10%. during the same period, a low risk investment, such as intermediate-term government bonds, had returns in excess of 47%. couple the return data with the negative news being released in 2001 and 2002, and you can understand the general reluctance of investors to buy or even hold high-yield debt. at the start of 2002, spreads made one final push higher and actually increased by 4% over the next nine months. at that point, the reward for owning junk bonds was now a full 10% over treasuries. this was a significant point in time for the highyield market. the spread over 10-year treasuries had not been this wide since early in 1991. over the next six or so years, as spreads narrowed, the asset class had returns approaching 150%. facing such a large spread for the first time in more than a decade would seem to be appealing. that is, only if it was possible to look beyond the shortterm issues facing the high-yield bond market. while the returns of high-yield bonds from october 2002 to the present cannot rival those in the early to mid 1990s, there has been substantial outperformance in the last 4 years over the broader fixed income market. in 2003 alone, the category was higher by more than 25%. that was certainly a healthy reward for those willing to take on what was perceived as a high risk investment in 2002. it should be noted when spreads move, they can move quickly. looking at the chart again, spreads contracted drastically from 1992 to 1993, dropping more than 6%. they expanded from below 3% in the fall of 1998 to above 8% a year later. and, of course, there was a drastic drop from late 2002 to late 2003, delivering the 25% return for high-yields. spreads quickly fell throughout 2003, and were under 4% again by the end of that year. although not shown, the mean spread for high-yields vs. treasuries over the past quarter century has been 4.75%. spreads have stayed under 4% since 2004, for the most part hovering between 3% and 4%. defaults have also declined in recent years. in mid 2002, defaults were close to 10%. as performance of the category took off and spreads shrunk, defaults seemed to move along with them. today, default rates have moved to 1.7%, a 20-year low. we reduced our exposure to the high-yield category in 2005, slowly moving from overweight to underweight. after benefiting from the excellent climate for the category in the prior two years, we felt it was appropriate to take profits and shift the money to other attractive fixed income categories. as mentioned earlier, spreads had declined significantly and were less compelling than the prior two years. even though we reduced exposure to high-yields, we still maintained a sizable exposure in the area. given the low default rate and low overall interest rate environment, even a spread of 3% over treasuries was significant. for the most part, proceeds from the reduction of highyield bonds were shifted to senior secured floating-rate bonds bank loans ; . with short-term rates below 3%, we felt that the greatest risk to a fixed income portfolio at the time was interest rate risk. given their historically low levels, the likelihood of continued rate hikes that had started in mid 2004 seemed fairly certain. moving assets to traditional bonds in 2005 would have placed that money under significant interest rate risk. the floating-rate instruments primary risk, much like high-yield bonds, comes from credit. since these loans reset their interest rate each week, interest rate risk is eliminated. coming off a low interest rate base, this type of investment was a very attractive alternative. the u.s. economy and stock market have been surprisingly resilient in the last 18 months. amidst concerns over inflation, a housing market slowdown, and general concerns over a possible looming recession, the market has moved higher and the economy has held strong. in this time period, defaults have actually been on the decline. as mentioned earlier, defaults stand at 1.7%, down from 2.5% in early 2006. the historical average default rate is 4.9%. this environment has been beneficial to highyield bonds, allowing them to continue their outperformance over the broad fixed income market. in 2006, high-yields returned nearly 12% while the lehman brothers aggregate bond index continued from page 6 and triple play poker.
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