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June 26, 2020Fallen Angel Bonds: Downgrades Create Opportunities (9:03)
Fran Rodilosso
Fran Rodilosso
Head of Fixed Income ETF Portfolio Management, CFA
Market uncertainty earlier this year has led to a record increase in the market value of fallen angel bonds. Fran Rodilosso, Head of Fixed Income ETF Portfolio Management, explores what this means for investors and what to expect heading into the latter half of the year.

Jenna Dagenhart: Hello, and welcome to Asset TV. Joining us today to cover fallen angels in the current market environment for bonds is Fran Rodilosso. He's Head of Fixed Income ETF Portfolio Management at VanEck. Fran, what are you hearing at road shows right now? And how is the coronavirus pandemic impacting bonds, broadly speaking?

Fran Rodilosso: Hi, Jenna. Thanks for having me today. Well, hearing a lot of questions at road shows, concerns about credit markets, in general, and particularly, with regard to fallen angels—just how many more are we going to see this year? Will it overwhelm high yield markets? And on the flip side, we're hearing a lot of questions about the [Federal Reserve (Fed)] and their involvement in credit markets now, and whether or not that provides a put for the entire market or what kind of support that is having.

But obviously, COVID-19 is the story underlying all of this because the impact it has had on the economy forced a sudden change in outlooks for—obviously economic growth—but from the perspective of borrowers in debt markets, their earnings, their leverage, and of course, their ratings.

Jenna Dagenhart: So Fran, moving forward, do you think that we will see more downgrades in fallen angels in light of the COVID crisis?

Fran Rodilosso:  Yes, almost certainly. The ratings agencies did act really quickly when the crisis first hit and the economic outlook changed. And we saw a record number in terms of volume of market value of fallen angels, $100 billion in the U.S. high-yield market of new fallen angels just through the end of April 2020. And we expect we'll see another potentially $150 to $200 billion on top of that by the end of the year. And mind you, $100 billion is the most we've seen in terms of market value of fallen angels, historic.

Jenna Dagenhart: And we could see another $150 to $200 billion on top of that?

Fran Rodilosso: Yes, that's certainly in the realm of possibility. VanEck has a baseline estimate that can hit that range. And that's not too different from a lot of predictions by banks and independent research firms.

Jenna Dagenhart: And Fran, looking at the high yield spreads, is risk priced in? And could there be opportunities for investors in this space?

Fran Rodilosso: High yield is pricing in still a fair amount of risk, probably more than equity markets by early June. Although, all markets have recovered a lot from late March when spreads on high yield hit historic highs—types of levels we had not seen outside of 2008-2009. Even with some spread tightening, and pretty consistent spread tightening since then, I think there are a lot of interesting opportunities in the market.

The biggest volume of new high yield—not offerings now—where most of the new high yield bonds are coming from are via fallen angels. It had a record year, $100 billion market value of new fallen angels. As we said, we expect to see a lot more of that this year. That's an area of particular interest to us. There have been three or four periods in the past with very high volumes of fallen angels. Those have corresponded with the best years of performance of a pure fallen angel strategy versus broad high yield.

Also, what's interesting to note is large volumes of fallen angels tend to be a lagging indicator. And the bigger chunks, the bigger occurrences of fallen angels tend to happen after the credit cycle has bottomed out. We think for people following the fallen angel part of the high yield market, there's a particularly interesting opportunity this year. And what we've seen with that $100 billion of bonds that have come into the market so far this year via downgrade from investment grade to high yield, those bonds have been entering high yield and fallen angel indexes in the low to mid-80s, in terms of cents on the dollar. So big discounts, trading 20% to 25% below where they had been trading six months ago, or at the beginning of the year. So much more extreme moves. They're even underperforming other parts of the market as they enter the high-yield space. And most of these are still in BB credits. In fact, a fallen angel index is over 90%, about 92% BB-rated right now. There's a little bit of a quality aspect in the fallen angel space as well, relative to broad high yield.

Jenna Dagenhart: Anything else you'd like to highlight, Fran, in terms of ratings, trading volumes and liquidity?

Fran Rodilosso: Well, sure, in the case of all three. One, we really have seen what's happened with $100 billion of new fallen angels this year—Fed support for credit markets in general, notwithstanding. Fallen angels have underperformed other parts of high yield or the credit spectrum before falling or just post-downgrade in the case of a few of the surprise downgrades. So, we've really seen the dynamic of fallen angels underperforming before they enter high yield indexes, which makes them an interesting opportunity set for this year.

In terms of liquidity, there was a week or two in March where bid-ask spreads were extremely wide compared with almost any other historical period, but trading volumes still remained elevated. And I think electronic trading platforms have had a lot to do with a lot of trades still getting done through the volatility. So, if you look at March trading volumes for investment grade and high yield debt, the hit ratio—the number of inquiries that actually led to successful trades was quite low—but the number of inquiries was extremely high.

You actually saw a lot of bonds changing hands. Fallen angel indexes have had extremely high turnover this year. We have a product, of course, that follows one of those indexes, which itself has had 50% turnover this year. We've been able to execute that with a fairly good degree of efficiency, to give you an idea of markets still functioning.

Jenna Dagenhart: And finally, as we move into the second half of the year, Fran, how will you be watching the Fed's actions?

Fran Rodilosso: Well, there are so many different measures to look at now with the Fed, because there still is the interest rate target and yield-curve targeting that they are talking about more presently. But what has probably provided the biggest boost, especially to credit markets since late March, are their primary and secondary market corporate credit facilities. And we will be watching how they actually deploy that, especially after spreads corrected back from the highs they hit in late March.

It's interesting to note that the Fed has been very, very slow to deploy the up to $750 billion in capital. By the way, $500 billion of that is allocated to the primary market or new issues, and $250 billion to buying bonds in the secondary market and, as they mentioned, ETFs. But by early June, the Fed had spent just about $5 billion of that money. So that was more than two months after the program was initially announced, just $5 billion spent, all on ETFs, presumably at that point, and the vast majority of that on investment grade ETFs.

So I think the market's reaction or the talk about support for certain parts of the market—especially the riskier parts of the market, such as high yield—there still remains a lot to be seen on how that will actually play out.

Jenna Dagenhart: Well, Fran, thank you so much for your time and your insights. Great to have you.

Fran Rodilosso: Thanks a lot, Jenna.

Jenna Dagenhart: And thank you for watching. That was Fran Rodilosso of VanEck, and I'm Jenna Dagenhart with Asset TV. To receive regular updates from VanEck's experts, please visit


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