Fallen Angels: The Year In Review

Fallen angels¹ outperformed the broad high yield² index by 0.72% in December and by 7.89% in 2020 (14.06% vs 6.17%).³ December was a relatively quiet month in terms of downgrades, but strong from a return perspective (2.63% vs 1.91%)⁴ as spreads continued to tighten and ended the year slightly lower than where they started.

2020 in Review

2020 was a roller-coaster year for the high yield market. In March, we saw massive spread widening followed by downgrades from severe economic disruptions due to Covid, and the U.S. Federal Reserve (Fed) stepping in to purchase individuals bonds and ETFs, which marked the beginning of a significant spread tightening cycle.

• Fallen angel spreads ended the year below where they started, but experienced significant volatility, reaching 954bps at the widest levels in March
• Top 2020 Sectors: Telecom an Energy contributed over 50% of the 7.89% of outperformance over broad high yield⁵
• Top 2020 Issuers: New fallen angels contributed 84% of the outperformance over Broad High Yield⁶
  • The top five new fallen angel contributors were Occidental Petroleum (OXY), EQT Corporation (EQT), Kraft Heinz (KHC), Cenovus and Ford – following what we wrote back in August
• Outperformance for the year was primarily explained by security selection, with positive contributions from within each sector
• Allocation effect was also significantly positive, with the overweight to Energy being the biggest contributor⁷
• Interest rate movements also contributed positively to outperformance. Fallen angels have a longer duration compared to the broader high yield market, on average.⁸ Historically, interest rate movements have not been a primary driver of long-term outperformance relative to the broader market.

Fallen Angels May Continue to Outperform in 2021

We believe fallen angels can continue to provide outperformance potential versus the broad high yield market, as they have through various credit cycles. Long-term historical returns have been explained by three primary drivers, which can have differing impacts depending on the market environment: a fallen angel technical effect, contrarian sector exposures and higher average credit quality. While 2020 was dominated by the fallen angel technical effect, we believe all three of these drivers have the potential to meaningfully contribute to returns this year. The chart below details five periods where the broad high yield spreads were below the long-term average and that fallen angels have consistently outperformed the broad market in these periods. In the current period, starting late July, fallen angels are already ahead by over 3%.

Fallen Angels Have Outperformed in Tight Spread Environments

Source: ICE Data, VanEck.

Source: ICE Data, VanEck.

2020 Overall Statistics

For the first time, the average yield to worst (YTW) of the fallen angel index dipped below 4%. The increase in duration, market value and number of issues is explained by the large number of downgrades that occurred earlier in 2020. Fallen angels are those bonds having been issued with investment-grade status and then downgraded. As a result they typically have longer dated maturity and longer duration, thus duration significantly increased from 5.92 to 6.82.

Source: ICE Data, VanEck.

A New Fallen Angel

A new issuer entered the fallen angel index at the end of December: Seagate HDD Cayman – the only Tech related fallen angel in 2020. The total amount of new fallen angels in 2020 was about $165B, with the vast majority coming in April month-end after the first wave of lockdowns in the U.S.

Source: ICE Data, VanEck.

No Rising Stars in December

Performance by Sector

Autos joined the fallen angel index in 2020 when Ford was downgraded. Energy and Utility issuers were the other two industries that saw their weights increase. The average spread on Energy sector bonds, which account for 29% of the fallen angel index, tightened significantly from the elevated levels in March and April, and is now lower than the beginning of 2020. Bonds of Telecom and Energy issuers contributed almost 50%⁹ to the Index outperformance vs broad high yield to the YTD figure.

Source: ICE Data, VanEck.

Performance by Rating

Throughout 2020, the fallen angel index increased its exposure to higher quality bonds from 77% in the beginning of January to 95% at the end of the year. The increase in higher quality bonds was due to the record number of issuers downgraded as the economy shut down in the early part of the year. As expected, all of the issuers joined the index with BB credit ratings. For the month of December and despite the inclusion of one new fallen angel, there were no significant changes to the overall rating weight. Notably, CCC and lower-rated bonds performed best in the last few months of the year after general optimism with the vaccine announcements, but fallen angels continued to outperform the broader high yield market.

Source: ICE Data, VanEck.