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Wartime finds investors eager for risk-taking

THE BALTIMORE SUN

New York

War may scare passengers off planes and shoppers away from the malls, but the opposite reaction is evident in the enthusiasm investors are showing for several of the riskiest areas of the financial markets.

Baltimore-based T. Rowe Price reports that beginning in mid-January, and more decisively in the past three weeks, two of its most closely watched investment vehicles, the venerable New Horizons Fund, composed of small-company stocks, and the High Yield Fund, composed of "junk" bonds, have gone from among the least popular to the most popular Price offering.

"It's too soon to say it's a trend," said Price spokesman Steven Norwitz, "but we're watching it."

The business prospects for small companies, and the likelihood that "junk" bonds will meet their repayment obligations, will be vastly enhanced if the economy recovers. Conversely, a deepening recession could be especially painful, since "junk" bond issuers and fast-growing small companies almost by definition lack deep financial cushions.

Given recent broad indicators, the economy would seem to be showing more signs of distress than health. Retail sales show their first year-to-year decline in 30 years, industrial production is weakening, and corporate profits are deteriorating. But the financial markets appear to be concluding that good news is coming. The rising prices for the securities in the two Price funds suggest that optimism is now stretching even to those areas where it hasn't been evident for months (in the case of junk bonds) or years (in the case of small companies).

The change in the fortunes of the New Horizons Fund is particularly striking. It was founded in 1960 with a simple mission -- to reap especially large gains through latching on to especially fast growing companies that, for mathematical reasons if for no other, are more likely to be small than large.

At times, this has been the case, notably in the mid-1960s and from 1976 through 1983. But the past bull market primarily just made the large larger and left out the small.

From June of 1983 through the end of 1990, the New Horizons Fund provided a return to investors of just 17 percent, about 10 percent of what an investment in the companies included in the Standard & Poor's 500 stock index yielded.

Noting the dismal comparison, a fixed element at T. Rowe Price's annual investment outlook session in New York in recent years has been a forecast of better days for the New Horizons Fund.

In 1990, it was a good prediction. Since the end of the year, the return on the fund has been about 20 percent, almost double the rise in bellwether stock-market indexes such as the Dow Jones industrial average or the Standard & Poor's 500.

Since its recent low in October, the fund's return to investors has been 44 percent and the size of the fund has swelled from $755 million to $1.075 billion, mostly because of the appreciation of the securities in the fund. Recently, investors have taken note, and Price says new money is flowing in.

Does the rise make sense? "The earnings of the companies [in which the fund is invested] haven't gone up 44 percent," said New Horizons' president, John Laporte, "and there isn't a meaningfully different fundamental outlook today than four months ago -- other than that we are four months closer to the end of a recession. Clearly the market is anticipating a . . . recovery in the second half of 1991."

In typical stock market fashion, the rally came only after the fund appeared to be falling to new lows. The average price-earnings multiple for the fund's stock holding had sunk below the market's average for only the second time in its 30-year history, and the third-quarter performance was awful -- down 26 percent.

"Part of what you see now is a snapback," Mr. Laporte said.

The fast rise in price inflated the fund's price-earnings multiple to 17 from about 12. But, because the overall market has gone up too, the fund's multiple is just a fraction of a percentage point above average, rather than twice as high -- as has often been the case in the past before especially strong appreciation in New Horizons' shares flagged.

Based on historical measures, prices 17 times earnings are high for the stock market, prompting an undercurrent of bewilderment and skepticism among some investment analysts, but the narrow spread between the ratio of the New Horizons Fund and the overall market encourages Mr. Laporte to believe that a further advance is sustainable, if delayed.

"Shorter-term, we've had one of the most dynamic moves in five or six weeks we've ever seen," he said. "It would only be healthy to pause and catch your breath."

If the thrust of the New Horizons Fund has drawn murmurs, any positive movement at all in T. Rowe Price's high-yield fund has prompted howls. Only three months ago, Richard Swingle, the fund's president, was skeptical about its near-term prospects, musing that a few major bumps were left before a resurgence.

But junk bonds, perhaps the most disparaged investment security in the history of investment securities, appear to have a certain undiminishable charm. An approximate gauge tracked by Lipper Analytical Services, a Wall Street research firm, reckons the average yield on junk bond mutual funds is about 15.1 percent. Ten year Treasury bonds yield is about 7.9, making the advantages of junk compelling -- if the bond issuer doesn't go broke.

"If you can get twice the yield, is it [investing in junk] worth it?" Price's economist George Boltz mused recently. "If you believe the recession is more than half over, it is."

And many do. After a steady shift of money away from the high-yield fund beginning in late July, new money has begun to pour in, largely because of transfers from money-market funds, Mr. Norwitz said.

Fears of default apparently have been damped by the rescue of several junk issues through the sale of their issuers to well-heeled buyers, for instance Harcourt Brace Jovanovich to General Cinema and Tonka to Hasbro, said Mark Vaselkiv, a Price investment manager. And several others issues, such as RJR Nabisco and Fort Howard Paper, were recapitalized with new equity.

That has generated euphoria in a highly illiquid market where even small shifts in emotion can have a dramatic impact. Bellwether bonds have soared. For instance an RJR Nabisco bond maturing in May 2007 sold for as little as 57 percent of its face value in the second quarter of last year and 85 percent at year's end, Mr. Vaselkiv said. Yesterday, it was selling for 118 percent of face value, a change of nearly 40 percent this year alone.

Strong rallies also have had a dramatic impact on the prices of other issues that had declined sharply, including Stone Container (a paper company), American Standard (plumbing fixtures) and Burlington (textiles), according to the trading desk of Donaldson, Lufkin & Jenrette, a major participant in the market. It is important to note that the moves have not come because the companies themselves have shown stronger performance.

"There's just been a more positive appraisal of the outlook," said Catherine Montgomery, manager of high-yield research for Donaldson, Lufkin & Jenrette.

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