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    Rising Rates and Fallen Angel Bonds

    Nicolas Fonseca, CFA, Associate PM
    April 19, 2021
     

    While rising rates are generally negative for rate sensitive asset classes like fallen angel high yield bonds, the reason behind the latest rate moves may provide support for fallen angels. Historically, the fallen angels indexhas provided positive returns and outperformance vs the broad high yield indexin most rising rate periods. Higher rates reflect expectations for stronger growth, which is generally positive for high yield bonds. The fallen angels index, in particular, may benefit due to a higher weight towards economically sensitive sectors which may have stronger participation in the ongoing economic recovery.

    These factors have historically benefitted fallen angel returns, helping to overcome the impact of rising rates. Looking back at the 15 previous periods when the 10-year rates went up, there was only one—March 2004 to June 2004—in which the returns for the fallen angels index and broad high yield bonds index were negative.Although the longer duration of fallen angels has played a detracting role amid rising interest rates, on average the fallen angels index outperformed the broad high yield market index overall (returning 8.97% vs. 7.69%, respectively) over the 15 periods where the 10-Year rate rose.Over the most recent period, as 10-year yields rose from 0.52% to 1.75%, fallen angels returned 8.55% and broad high yield returned 7.14%.5

    Rising Rates Historically Benefit High Yield and Fallen Angel Returns

    Rising Rates Historically Benefit High Yield and Fallen Angel Returns

    Source: VanEck, ICE Data Indices, US Treasury

    A Closer Look at the Most Recent Rising Rate Period

    A Closer Look at the Most Recent Rising Rate Period

    Source: VanEck, ICE Data Indices, US Treasury

    Despite a rough March, when the 10-Year yield jumped 21% from 1.44% to 1.74%, the fallen angels index ended Q1 in positive territory, with underperformance vs. broad high yield index for the month mainly attributable to its longer duration.

    The yield to worst of fallen angels index started the year at 3.80% and hit all-times lows in mid-February (3.60%). Since then, it increased along with rising interest rates and went above 4.00% in March, but ended Q1 at 3.91%. In comparison, the yield to worst of while broad HY high yield index barely changed from the beginning of the year. In Q1, the average duration of fallen angels decreased while broad high yield index duration has increased. As of March 31, the fallen angels index had a 6.70 duration to worst compared to 3.68 for broad high yield index.

      Fallen Angel Index Broad HY Index
      12/31/2020 3/31/2021 12/31/2020 3/31/2021
    Yield to Worst 3.80 3.91 4.24 4.27
    Mod. Dur to Worst 6.82 6.70 3.37 3.68
    Full Market Value ($mn) 252,730 233,333 1,543,269 1,554,247
    No. of Issues 328 308 2,030 2,049

    Source: VanEck, ICE Data Indices

    New Fallen Angel Bond

    One fallen angel bond joined the index in March, adding ~$0.9B of debt to a total of $2.1B for the first quarter of 2021, bringing the total number of new fallen angels in Q1 to three. Over the six months prior to index entry, the price return for TechnipFMC was 0.65%, Hexcel Corp. -2.67% and Patterson-UTI Energy 24.64%. Prior to being downgraded, bonds are typically oversold as the market anticipates a rating action. Although on average this has resulted in price declines of downgraded bonds, the returns of TechnipFMC and Patterson-UTI illustrate that this is not always the case. These issuers’ price returns reflect the recovery in the energy sector from March 2020 lows.

    Month-End Addition Name Rating Sector Industry % Mkt Value Price
    February TechnipFMC plc BB1 Energy Oil Field Equipment & Services 0.20 104.20
    February Hexcel Corporation BB1 Capital Goods Aerospace/Defense 0.31 106.15
    March Patterson Uti Eneg BB1 Energy Oil Field Equipment & Services 0.37 96.01

    Source: VanEck, ICE Data Indices. Past performance is not indicative of future results.

    Rising Stars Emerge

    Two rising stars exited the index in March. They joined Cenovus for the year, removing approximately $7.3B in debt from the index. Nordstrom entered the index not long ago (one of the many fallen angels in 2020), but Smurfit Capital has been in the fallen angel index since 2003.

    Month-End Deletion Name Rating Sector Industry % Mkt Value Price Face Value
    January Cenovus Energy Inc. BB Energy Integrated Energy 2.25 115.88 4,886
    March Nordstrom Inc. BB Retail Department Stores 0.23 102.12 2,181
    March Smurfit Capital Funding plc BB Capital Goods Packaging 0.16 122.87 301

    Source: VanEck, ICE Data Indices. Past performance is not indicative of future results.

    As we mentioned earlier in the year, rising stars have historically provided price appreciation over the 12 months before fallen angels are upgraded. Looking at this year’s rising stars so far:

    • Cenovus returned 49% for the nine months it was in the index while broad high yield returned 13% during the same period.
    • In the six months Nordstrom was in the index, it returned 25% vs. 4% for the broad high yield.
    • Smurfit Capital was a different story. Smurfit Capital is a leading packaging company that generates a majority of its revenue from products that are sold quickly and at a relatively low cost, which was beneficial during the pandemic as people stayed home and had many items delivered to their doors. It only returned 3% while the broad high yield market returned 24%, although for context 12 months ago put us in March 2020, right at the bottom of COVID crisis. Longer term, the upgraded bond, which has been in the index since 2003, has outperformed the broad high yield market by more than 300bps per year over the past decade.

    2021 Rising Stars

    2021 Rising Stars

    Source: VanEck, ICE Data Indices. Past performance is not indicative of future results.

    Energy Sector Still Dominates Fallen Angels Index

    The sector weighting for the fallen angels index remained fairly consistent throughout Q1. Fallen angels are still dominated by the energy sector, which outperformed the index during the quarter, as oil prices rallied sharply since the end of last year.

    ICE US Fallen Angel High Yield 10% Constrained Index Sector Weighting

      Wgt (%) OAS Price Quarterly TR %
       12/31/2020   3/31/2021   12/31/2020   3/31/2021   12/31/2020   3/31/2021   3/31/2021 
    Automotive 10.00 10.00 274 232 106.31 106.21 0.54
    Banking 3.64 3.92 215 176 116.71 115.62 0.25
    Basic Industry 6.94 7.08 236 192 114.88 112.81 (1.08)
    Capital Goods 3.08 3.25 305 275 110.43 108.67 0.10
    Consumer Goods 12.38 12.64 221 160 114.82 112.78 (0.82)
    Energy 28.83 28.38 393 343 99.25 98.48 1.63
    Financial Services 0.92 0.95 263 216 124.95 120.02 (2.73)
    Healthcare 0.48 0.51 369 261 109.42 112.47 4.03
    Insurance 0.42 0.47 673 541 94.84 97.62 4.33
    Leisure 4.85 4.84 372 309 112.40 112.97 1.96
    Real Estate 3.77 4.05 511 452 96.45 96.39 0.81
    Retail 3.55 2.65 427 319 98.33 100.92 4.11
    Services 1.01 0.90 232 226 103.42 102.69 0.66
    Technology & Electronics 4.24 4.40 224 199 110.26 108.54 (0.63)
    Telecommunications 7.48 7.71 272 251 131.86 125.08 (3.72)
    Transportation 1.96 1.67 336 363 100.97 99.93 0.28
    Utility 6.45 6.58 207 200 111.11 107.44 (2.26)
    Total 100 100 313 267 107.67 106.58 0.18

    Source: VanEck, ICE Data Indices

    Fallen Angel Bonds Credit Quality Remains Steady

    Fallen angel bonds continue to provide a heavy tilt towards higher quality high yield bonds. At quarter-end, 94% of fallen angels were rated BB, the highest rating category within high yield. Lower rated bonds, however, performed best in Q1 as investors prepared for the economy to get back on track. These bonds usually pay higher coupons, which offer some protection against rising yields. They are also favorable when expectations for growth is high as defaults tend to be low.

    ICE US Fallen Angel High Yield 10% Constrained Index Credit Quality

      Wgt (%) OAS Price Quarterly TR %
      12/31/2020 3/31/2021 12/31/2020 3/31/2021 12/31/2020 3/31/2021 3/31/2021
    BB 94.56 94.02 296 246 108.81 107.53 (0.12)
    B 3.96 3.96 470 471 99.34 100.70 3.30
    CCC 1.14 1.60 639 539 91.66 95.76 7.89
    CC 0.15 0.21 2,254 1,604 33.99 46.59 40.07
    C 0.19 0.20 2,321 2,365 60.03 60.68 (2.85)
    Total 100 100 313 267 107.67 106.58 0.18

    Source: VanEck, ICE Data Indices

    DISCLOSURES

    Fallen angels index refers to the ICE US Fallen Angel High Yield 10% Constrained Index (H0CF).

    Broad high yield (HY) index refers to the BofA US High Yield Index (H0A0), also referred as the broad benchmark.

    Source: VanEck.

    Source: VanEck.

    Source: VanEck.

    A fallen angel bond is a bond that was initially given an investment-grade rating but has since been reduced to junk bond status.

    High yield bonds may be subject to greater risk of loss of income and principal and are likely to be more sensitive to adverse economic changes than higher rated securities.

    Please note that VanEck may offer investments products that invest in the asset class(es) included herein.

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    The information herein represents the opinion of the author(s), but not necessarily those of VanEck, and these opinions may change at any time and from time to time. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Any discussion of specific securities/financial instruments mentioned in the commentary is neither an offer to sell nor a recommendation to buy these securities. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only.

    ICE BofAML US High Yield Index (H0A0, “Broad HY Index”), formerly known as BofA Merrill Lynch US High Yield Index prior to 10/23/2017, is comprised of below-investment grade corporate bonds (based on an average of various rating agencies) denominated in U.S. dollars.

    ICE US Fallen Angel High Yield 10% Constrained Index (H0CF, Index) is a subset of the ICE BofA US High Yield Index and includes securities that were rated investment grade at time of issuance.

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    All investing is subject to risk, including the possible loss of the money you invest. Bonds and bond funds will decrease in value as interest rates rise. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

  • Authored by

    Nicolas Fonseca, CFA
    Associate PM

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