A Flying Start for Fallen Angel Bonds

January 2023 was the strongest start to a calendar year since 2019, where broad HY posted 4.59% and fallen angels 4.67%. Still, CCC & Lower rated bonds took the lead with a 6.22% return, despite the majority of the fixed income ETF sector flows, according to Citi, going to Treasury and investment grade corporates, with a preference for higher quality and intermediate duration. High yields corporate flows were +$0.5bn for January vs. +$5.0bn for Treasury and +$7.2bn for IG corporates. Fallen angels (as represented by the ICE US Fallen Angel High Yield 10% Constrained Index, Ticker: H0CF; subsequently referred to herein as “the index”) underperformed broad HY (as represented by the ICE BofA US High Yield Index, Ticker: H0A0) by 0.05% (3.86% vs. 3.91%) for the first month of the year due to higher quality composition of the fallen angels.

High Yield Returns (January 2023)

Source: ICE Data Services and VanEck. Past performance is no guarantee of future results. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Broad HY: ICE BofA US High Yield Index.

How long will the January Effect persist for high yield bonds? The macro-environment remains mixed as the cumulative impacts of Fed tightening continue to work through the economy. However, three consecutive downside inflation metrics, China’s reopening, the IMF upgrading its global growth outlook for the year, and the possibility that the Fed, which hiked by the expected 0.25% in their February meeting, will stop soon and maybe even cut at the end of this year have given the “soft landing” scenario some legs. Since the fallen angel index launched in December 2003, there have been 16 calendar years when its January total return was positive (not including 2023). Of those 16 years, 14 ended the year with positive total returns. We believe that elevated yields and the potential price appreciation from rating migrations, both additional rising stars and potentially an increase in fallen angels, will be the likely drivers of total return this year, with the higher quality of fallen angels providing some cushion if the market experiences volatility ahead.

Source: ICE Data Services and VanEck. Past performance is no guarantee of future results.

Fallen Angels Overall Stats: Yield to worst for both fallen angels and broad high yield have fallen alongside 10Y Treasuries but are still elevated as one year ago, the YTW was 4.33 and 5.31, and the 10Y was 1.79. Duration increased for fallen angels and shortened for broad HY, something that, if it continues, should benefit fallen angels as long duration bonds (measured by the ICE BofA Current 30-Year US Treasury Bonds) posted 6.15% in January.

Source: ICE Data Services, VanEck. Past performance is no guarantee of future results. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Broad HY: ICE BofA US High Yield Index. OAS refers to “option-adjusted spread.” Please see definition for this and other terms referenced herein in the disclosures and definitions portion of this blog.

New Fallen Angels: None

Rising Stars: None

Fallen Angels Performance by Sector: The sector composition didn’t change significantly; however, the Utility sector saw a decrease of 1.32% as Electricite de France was removed from the index as it didn’t have at least one-year remaining term to final maturity as of month-end. All sectors posted positive returns, with the Financial Service taking the lead after a 6.82% return and Healthcare at the bottom with 2.64%, and spreads tightened for all sectors except for Consumer Goods, where it was flat. The index price is now above $90m, still below its long-term average of $95.62, but seeing an upward trend since the middle of October when it was in the mid $80s. The Banking sector is the only sector above par, and there is now more than ¾ of the index in the $90s.

Source: ICE Data Services, VanEck. Past performance is no guarantee of future results. Not a recommendation to buy or sell any of the names/securities mentioned herein. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index.

Fallen Angels Performance by Rating: Lower-rated bonds outperformed their high-quality peers during this past month. Something to look out for in the coming weeks will be the default of Bed, Bath, and Beyond, which had a weight of 0.03% in the index as of 1/31/2023.

Source: ICE Data Services, VanEck. Past performance is no guarantee of future results. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index.

Data throughout was sourced from ICE Data Services and VanEck as of 1/31/2023.

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