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10 HIGH-YIELD INVESTMENTS
Opportunities abound in the sectors that were most thoroughly devastated by jittery investors.
by Trevor Gan

hat investor doesn't dreams of netting high yields? Those dreams are fueled by stories of masterful operators who parlay thousands into millions in a skunk's lifetime. As someone who has paid a steep price for believing those stories, I want to ground this discussion on two concepts without which talk of high-yield investment is utterly meaningless.
     The first is risk. Invest $10,000 in a high-yield junk-bond fund and average a 22% return for three consecutive years. You feel like a master of the universe. The next year the sector underlying your investment tanks and some companies go belly up and others scramble to stay solvent. Say you are one of the lucky ones who loses only half the value of your cumulative investment. Was that really a high-yield investment? Your average annual return for those four years would have been about negative 4%. Your mattress would have produced a better yield.
     The U.S. Treasury Department estimates that investors lose $10 billion every year solely from fraudulent high-yield scams falsely invoking U.S. Treasury involvement. No one knows exactly how much is lost through other high-yield scams, but an intelligent estimate would be a multiple of that figure. That doesn't even include the primary source of losses from high-yield investment: default or collapse of the companies (or even governments) issuing the underlying securities. A realistic estimate of average annual losses through investments seeking high-yields during the past decade would be $500 billion. That's almost a third of all funds placed in so-called high-yield investments.

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     Does that mean high-yield investments don't exist? No, but it does means that by their nature high-yield strategies must tap volatile windows of economic opportunity -- the other concept that defines high-yield investments. What does that mean in English? It means you can't just leave your money in the same place year after year and expect a high yield. That would be begging the law of averages to catch up and reduce your investment to a very average yielding one, or worse. Remember that none of the high-yield funds that are top performers during the past year are among the top performers over the past three or five years. Never forget that by their nature high-yield investments are a constantly moving target.
     That brings us to the point of this article -- the volatile windows of economic opportunity presented today for investors possessing above-average risk tolerance. The editors have asked me not to mention the names of specific stocks, bonds, funds or other investments. However, I can take you the first eight yards by setting out 10 sectors that have spooked investors but are about to regain respectability. In other words, these sectors present volatile windows of opportunity as of early spring of 2003. Most should present high yields for at least a year or two.
     For most sectors the easiest and safest way to invest is by buying sector-targeted mutual funds. Generally high-yield funds are invested 65-80% in debt of sector companies with credit ratings of Baa/BBB aka "junk bonds". These are what are known as "medium grade" companies. That means they have an adequate capacity to pay principal and interest when due but aren't solid enough to be called "investment grade". In other words, they make conservative investors nervous. Managers of high-yield funds also put a small percentage into speculative grade Ba/BB­rated bonds if they have some reason to think their issuers are on the upswing. Some aggressive ones also invest up to 10% directly in stocks. The remaining few percentage points of the funds generally stay in U.S. treasuries and cash.
     If you are a risk-taker who finds life meaningless without the possibility of returns above 10% and don't need the money for five or more years, put 25-40% of your investment capital into a diversified portfolio of companies that have demonstrated either strong market positions or have shown profits during at least two of the past four years. You can do it the smart (and safer) way by putting your money into mutual funds that target the sectors I am about to recommend. (IMPORTANT NOTE: This article is time-sensitive. It is intended to be used by those intending to make investments between mid-2003 through mid- 2004.)
     Here are the 10 sectors that I believe have the best chance of reversing their fortunes in the eyes of the investment community during the coming year and, therefore, should provide high yields on your timely investment. I've ranked them roughly according to the strength of their upside prospects.

1. Airlines
        Air travel took a big hit on 9/11, sending stock prices to below 10% of their 5-year highs. Their life-and-death struggles will continue into 2004, but management is using the opportunity to improve efficiency by cutting redundant staff and harnessing the internet to squeeze out middlemen. Their collective stock valuations should see large gains during 2003 as the efficiency gains will go to the bottom line. Plus, post-Iraq-war confidence should send travelers back into the air. Good sector to hold for a couple years.
   
   
2. Chain Restaurants/Fast-Food
        Dining out is the other major 9/11 casualty, crippling revenues of even family restaurants and most fast-food chains. Equities are at historic lows. As the unemployed start returning to work this fall, fewer people will have the time and energy to cook or brownbag. This is another good sector to hold for a couple years.
   
   
3. Broadband Wireless
        The entire telecom sector has been battered relentlessly for the past four years, and weak players will continue to exit. But the visionaries who put their chips on exploiting the exciting potential of broadband wireless, especially the so-called Wi-Fi (802.11) wireless networking standard, will ride a fresh wave of investor and user enthusiasm for the unplugged internet. This sector has begun to get investor attention and will see big runups in the coming year. Choose carefully and diversify broadly. Even allowing for a high attrition rate, the sector should return good overall yield.
   
   
4. E-Commerce and Online Media
        No sector has weathered quite the near-total devastation sustained by companies offering e-commerce and online media. Their promise had always been real and at long last the survivors are staggering into the promised land of profitability. They will be among tomorrows giants, representing huge potentials for investors who can shake off memories of recent carnage and wade back in. Good sector to hold for a couple of years. Focus more on brands with an exciting online image and a promising business model rather than graybeards squeezing out profits through sheer discipline. We are likely to see a revival of the internet craze, maybe even as early as this fall as the world finally grasps just how thoroughly the internet has infiltrated our lives.
   
   
5. Semiconductors
        As long as chips are associated with personal computers, the futures of their makers look cloudy. But the perspective changes when you see chipmakers as the leading edge of virtually every consumer sector, including appliances, robotics, entertainment, medicine, healthcare, cars, communications, manufacturing, retailing and even sportswear and food. Expect better yields from players who are establishing themselves in specialty niches.
   
   
6. Sportswear/Fashion Brands
        Boutiques and department stores lost ground to discount chains as the suit-wearing class saw their portfolios evaporate in the fin de si &egrav;cle crash. The deep concessions desperate designer labels made to lure bargain-hunters is now paying dividends as a new generation turns on to status brands thanks to a perennial reality of uncertain times: well-dressed people are more likely to impress employers, clients and dates. Premium labels will see gradual but solid gains for at least several years.
   
   
7. Software/IT Services
        The tech meltdown forced companies to defer IT infrastructure upgrades for four years. Worried that competitors are gaining an edge in efficiency, CEOs are now earmarking some of the savings from belt-tightening to catch up on systems and workstation upgrades. That means a nice bounceback for this long-suffering sector. But don't expect anything like the frenzy of the late 90s because investors are now savvy enough to distinguish between workhorses in the essentially mature software/IT sector and the few remaining potential racehorses in the internet sector.
   
   
8. Investments Services/Banking/Insurance
        The trillions of dollars scared out of the financial markets will start trickling back this spring. Sooner or later that trickle will turn into a torrent à la the late 90s albeit on a more restrained scale. That means tens of billions of revenue growth for investment bankers and brokerages. With P/E ratios far lower than the S&P 500, the sector could see a dramatic bounce back. The big uncertainty is whether that will take place later this year or not until mid-2004. The sector's vulnerability to economic volatility is what makes it an unusually good opportunity now that investors have factored in just about everything that a world-gone-mad can throw at them.
   
   
9. Aerospace/Defense
        The recent sabre-rattling has kept this sector from sinking lower than about 15% below 5-year highs. But even if prospects for a major war fade, it will enjoy sustained growth thanks to a rebound in civilian air travel coupled with aging airline fleets, and the long-debated push to create a hi-tech, quick-response military force. Look for modest but steady growth that should translate into strong yields over a 2-3 year span.
   
   
10. Energy/Petroleum
         The energy sector will inspire new confidence once war jitters start receding into memory and short-memoried motorists resume roadtrips and air travelers flock back to airports. Investments in this sector should do well for the coming year, maybe a year and a half. Holding it for longer is not recommended due to the strong possibility that cyclical fears of glut will materialize in early 2005 or beyond.