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Fallen Angels: an expression going back to pre-Christian times, referring to angels expelled from heaven or having sinned1.
Fixed income investors have been roaming the yield-deprived earth looking for returns; many hoping that COVID-19 state spending would push up interest rates. With euro sovereign yields, basically, at where we left off at the end of 2019, and with the U.S. Treasury having given up more than 100 basis points, investors may be frustrated. High yield bonds, however, form a notable exception. With spreads having spiked by 2.75%2 since the end of last year, it is an asset class worth considering for some. Whilst we acknowledge that it is not an asset class suitable for every investor; with central banks leading the way we believe that the emerging sub-category, “fallen angels” should be one to take seriously.
Fallen angels are high yield corporate bonds, that at the time they were issued, were considered to be investment grade, but have since “sinned”, and therefore have been expelled from investment grade “heaven”; or rather in more financial terms, have been downgraded to sub-investment grade.
A broad array of sectors is represented in the asset class, the largest currently being Energy, Banking and Automotive (figure 1).
Source: ICE, VanEck analysis. Data as of 31/5/2020. The breakdown is based on market values.
Often, these bonds are issued by large corporations with well-known brand names, such as Ford, PemEx, Vodafone and Intesa Sanpaolo (figure 2).
Source: VanEck. Data as of 31/5/2020. These are not recommendations to buy or to sell any security. Securities and holdings may vary.
To date, the outstanding nominal value of fallen angels amounts to USD 440 billion, constituting circa 20% of the global high yield volume (figure 3).
Source: ICE, VanEck analysis. Data as of 31/5/2020.
Historically, fallen angels have seen better risk adjusted returns than high yield bonds (figures 4 – 6).
Value of USD 100 initial investment
Past performance is not a reliable indicator for future performance, this also holds for historical market return.Source: ICE, VanEck analysis. Data for the period 1/1/2005 - 30/4/2020. Fallen angels are represented by the ICE BofAML Global Fallen Angel High Yield Index, high yield by the of ICE BofAML Global High Yield Index
Past performance is not a reliable indicator for future performance, this also holds for historical market returns. Source: ICE, VanEck analysis. Data for the period 30/4/2010 to 30/04/2020. Fallen angels are represented by the ICE BofAML Global Fallen Angel High Yield Index, high yield by the ICE BofAML Global High Yield Index. The Sharpe ratio is based on the risk free 1-month USD LIBOR rate.
Index composition (composite credit rating)
Source: ICE. Data as of 30/4/2020. Fallen angels are represented by the ICE BofAML Global Fallen Angel High Yield Index, high yield by the of ICE BofAML Global High Yield Index.
What can explain this historic outperformance? We see two reasons:
Historical performance is not a reliable indicator for future performance. Source: VanEck analysis, based on ICE data for the period 31/12/1999 to 30/4/2020. Fallen angels are represented by the ICE BofAML Global Fallen Angel High Yield Index, high yield by the of ICE BofAML Global High Yield Index.
These elements are also reflected in a return decomposition. As can be seen in figure 8, for most periods the price return of high yield bonds is negative. I.e., their market price drops while they are in the index; conversely, the price return of fallen angels is positive.
Historical performance is not a reliable indicator for future performance, this also holds for historical market return.Source: VanEck analysis, based on ICE data. Fallen angels are represented by the ICE BofAML Global Fallen Angel High Yield Index, high hield by the ICE BofAML Global High Yield Index.
The current market climate has contributed to two factors that create a unique case for this asset class.
Firstly, the available universe just increased by 50% compared to a year ago, while both yields and spreads have seen a significant uptake (figures 9 and 10). For example, in the U.S. there exists a positive correlation between the number of new fallen angels in a given year and the absolute returns of the index, as well as the returns relative to high yield (figure 11). Historically, the best years have been the ones during or immediately following large waves of fallen angels.
Issues in the ICE BofA Global Fallen Angel High Yield Index
Historical performance is not a reliable indicator for future performance, this also holds for historical market return. Source: VanEck analysis, based on ICE data. Data as of 31/5/2020. Fallen angels are represented by the ICE BofAML Global Fallen Angel High Yield Index.
Historical performance is not a reliable indicator for future performance, this also holds for historical market return.Source: VanEck analysis, based on ICE data. Data as of 30/4/2020. U.S. fallen angels are represented by the ICE US Fallen Angel High Yield 10% Constrained Index
Secondly, the ECB announced it would extend its Pandemic Emergency Purchase Program (PEPP) with an additional EUR 600 billion, up from the already announced EUR 750 billion in March. As of this moment, bonds need to be investment grade in order to be eligible for the PEPP. In late April the ECB announced that fallen angels would also be eligible as collateral for banks to have access to the ECB’s liquidity facility. As a result, market participants are expecting fallen angels to also become eligible for the PEPP. The U.S. Federal Reserve (Fed) is leading by example: in early May it announced that it would begin buying fallen angels as part of its Secondary Market Corporate Credit purchase program.
Central bank demand, combined with potentially improving economic forecasts, could provide further price support.
Many investors may see high yield bonds as a natural candidate for an actively managed fund. However, SPIVA research shows that for the U.S., the majority of actively managed high yield bond funds have not outperformed their benchmarks (figure 12)3. As a result, a passive approach may be more suited.
U.S. actively managed high yield funds
Historical performance is not a reliable indicator for future performance.Source: SPIVA U.S. scorecord, year-end 2019. Data as of 31/12/2019
For our investors we propose the VanEck Global Fallen Angel High Yield Bond UCITS ETF. The global scope of the fund enables an investor to benefit from economic cycle diversification, a larger number of potential issuers and currency diversification (figure 13).
Currency decomposition of the ICE BofA Global Fallen Angel High Yield Index, based on market values
Source: VanEck analysis, data as of 30/4/2020.
Most sin, even angels; therefore, by investing in them as they fall back to earth, one may benefit when they spread their wings and fly back up to the sky.
1Source: Mehdi Azaiez, Gabriel Said Reynolds, Tommaso Tesei, Hamza M. Zafer The Qur’an Seminar Commentary /Le Qur’an Seminar: A Collaborative Study of 50 Qur’anic Passages, cited in Wikipedia.
2Source: ICE, data as of 31/5/2020.
3We use U.S. high yield bond funds as a proxy, because of data availability. In theory, the conclusion could be different for a global remit. However, we deem this unlikely, as 1) the U.S. is the largest region (37%) of the ICE BofAML Global Fallen Angel High Yield Index (as of 30/4/2020), 2) the underperformance of actively managed funds is very significant over longer time periods, 3) our own research of the largest global high yield funds indicates that most underperform over time.
VanEck Global Fallen Angel High Yield Bond UCITS ETF (the “Fund”) is a sub-fund of VanEck UCITS ETFs plc, an investment scheme which is registered in Ireland and subject to the European regulation of collective investment schemes under the UCITS Directive. The Fund is registered as UCITS fund and tracks a bond index. The value of an ETF’s assets may fluctuate widely as a result of its investment policy. If the underlying index falls in value, the ETF also falls in value.
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