UPDATE 2-US junk bond demand hits fresh record

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By Dena Aubin

NEW YORK, Oct 29 (Reuters) - Investor appetite for U.S. junk bond mutual funds hit fresh record highs this week as a recovering economy and easy monetary policy kept investors comfortable with risk.

Cashing in on a relentless rally, investors poured a net $207 million into junk bond funds in the week ended Wednesday, pushing year-to-date inflows to $27.8 billion, the most ever, AMG Data Services reported on Thursday.

The previous inflow record was $26.96 billion for the full year 2003, according to AMG. Junk bonds, which are rated below investment grade, pay high yields to compensate for their risks.

The avalanche of money pouring into junk funds is creating a virtuous cycle: As cash pours in, shaky companies are able to refinance debt by selling new bonds, heading off defaults and adding fuel to the junk bond rally.

"In an environment where defaults are falling you still have pretty good potential for capital gains," said Andrew Feltus, manager of the Pioneer global high-yield fund. "Unless you really think we've got a double dip economic scenario coming, the high-yield market is still a good place to invest."

RETURNS TOP 51 PERCENT

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Junk bonds have rallied nearly nonstop since March, posting year-to-date returns of 51.3 percent, their best performance ever, according to Merrill Lynch indexes. The previous record return was 39.2 percent for the full year 1991.

"I still think there's a little bit of room for them to run, but they're not going to have the same return that somebody who bought them last fall is going to have - that's for sure," said Deborah Danielson, founder of Danielson Financial Group, a Las Vegas-based investment management firm.

Scared by the shaky performance of equities, many investors are favoring high-yield bonds as an alternative both to stocks and to low-yielding money market funds or bank certificates of deposit, she said.

Money market yields hit a record low of just 0.04 percent this week as short-term interest rates remained frozen at or near zero by the Federal Reserve to stimulate the economy.

Stock mutual funds year to date have attracted just $4.3 billion in net inflows, compared with $213.0 billion going to taxable bond funds, the Investment Company Institute reported on Thursday.

LOST DECADE IN STOCKS

"There are a number of investors that are more comfortable owning income-generating securities than ones that have the potential for capital gains, i.e., stocks, which didn't really materialize in the past decade," said Kenneth Monaghan, head of high-yield credit at Rogge Global Partners in New York.