Mutual Funds That Get High Returns From Low-Quality Companies

NEW YORK (TheStreet) -- Plenty of mutual funds focus on high-quality stocks. Their portfolios include familiar names such as Coca-Cola (KO) and Johnson & Johnson (JNJ) , companies with rock-solid balance sheets.

But Aquila Three Peaks Opportunity Growth (ATGAX) takes a different approach. The fund specializes in stocks with below-investment grade ratings. Buying low-quality names has proved to be a winning formula lately. This year Aquila has returned 16.5%, outdoing the S&P 500 by 6 percentage points and topping 99% of competitors in the mid-cap growth category, according to Morningstar.

Aquila is not the only investor to prosper by buying companies with heavy debt burdens and shaky balance sheets. According to a study by Morningstar, companies with above-average debt levels outdid those with below-average debt by 2 percentage points this year.

Part of the reason for the strong showing of low-quality investments has been a rally in high-yield bonds, which are issued by below-investment grade companies. Desperate for income, investors have been racing to buy high-yield bonds, which yield more than 6%. That has provided easy financing for low-quality companies. In addition, low-quality companies have climbed this year as optimistic investors have looked to boost returns by taking on more equity risk.

Among the top-performing low-quality funds this year is Putnam Capital Spectrum (PVSAX) , which returned 18.2% this year, outdoing all its peers in the moderate allocation category. Putnam Equity Spectrum (PYSAX) returned 16.1% and outdid 95% of peers in the mid-cap value category.

Perhaps the most notable low-quality fund is Fidelity Leveraged Company Stock (FLVCX) , which returned 18.4% this year. During the past 10 years, the Fidelity fund returned 15.4% annually, ranking as the top-performing domestic equity fund tracked by Morningstar.