UPDATE: Barclays Sees US Junk Bonds Returning 7%-8% In 2010

Junk bond and leveraged loan investors shouldn't bank on double-digit returns in 2010, according to analysts at Barclays Capital, who predict that earning a high single digit return for each asset class may be the best portfolio managers can hope for next year.

The risky junk bond and leveraged loan markets have staged an impressive comeback in 2009. Junk bonds have returned more than 52% since January, while leveraged loans have returned nearly 50%. Cash-rich investors, eager to put money to work, have driven up average prices on these risky bonds to 92 cents on the dollar from lows of around 55 cents in December 2008.

But this year's performance may have eaten into future returns and Barclays' analysts predict that junk bonds could return 7%-8% next year. This is below the expectations of some other market participants, such as Kenneth Taubes, head of portfolio management at Pioneer Investment in Boston, who estimates that junk bonds could return 10% to 11% in 2010. Returns on leveraged loans meanwhile could come in at 8% to 9%, according to Barclays' analysts.

Either way, returns are expected to be less than one-firth of the record returns seen this year. Through November high-yield bonds have returned 53.18%, while leveraged loans have returned around 49%, according to Barclays. This year's junk bond returns are nearly 7% beyond the previous record set in 1991, and 2009 has claimed five of the top 11 monthly returns of all time, according to the bank.

"Just as 2008 marked a flight to quality, 2009 reversed the trend," the analysts, led by Bradley Rogoff, wrote in a note published Friday.

The expected returns may not seem much by comparison - Barclays' analysts note that junk bond returns of 7% to 8% would rank only 15th out of 27 years of the High Yield Index - but they are probably realistic given the expected headwinds in 2010. The main concern is whether economic recovery will stall once governments begin to unwind fiscal stimulus programs and raise rates.

As such, demand for junk bonds won't be as "robust" next year. Even so, it should still be supportive for the asset class, according to the analysts, who anticipate that 2010 supply will be $120 billion to $130 billion, with refinancing continuing to represent the dominant use of proceeds, and deals to back acquisitions increasing from 2009 levels.

Speculative-grade companies have sold more than $131 billion of high-yield so far this year, according to data provider Dealogic. That is about three times the $47.7 billion issued in all of 2008.

-Kate Haywood, Dow Jones Newswires; 212-416-2218; [e-mail]