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There’s no denying it’s difficult to get excited about the fixed income space these days, but as is being noted of late, there are some pockets of opportunity in this arena even as the Federal Reserve drops the hammer on raising interest rates.
Some of those opportunities are found in the high-yield corporate bond world, including fallen angel bonds. Fallen angels don’t grab the attention of traditional junk bonds, but nonetheless, the concept is easily conveyed to clients.
In simple terms, fallen angels are corporate bonds born with investment-grade credit ratings that are later downgraded to junk territory. That makes the quality and return characteristics of this form of corporate debt different than bonds that come to market with junk ratings.
Translation: There are income and upside opportunities with fallen angels and with that in mind, it’s worth noting the VanEck Fallen Angel High Yield Bond ETF (ANGL) – the dominant exchange traded fund in this category – is celebrating its tenth anniversary.
Impressive Past Performance, Bright Future
As is frequently said in financial market parlance, past performance isn’t a promise of future returns. Still, it’s hard to ignore the fact that over much of its 10 years on the market, ANGL has been a better bet than traditional junk bond funds.
“We’ve seen both rising rates and declining rates, extremely wide and tight credit spreads, and several bouts of volatility over the past decade,” said William Sokol, VanEck senior ETF product manager, in a recent note. “Through these market cycles, fallen angels have outperformed the broad high yield market consistently and significantly, with outperformance in eight of the nine full calendar years since ANGL’s launch, with an average of over 400 basis points in those years.”
Despite that impressive run, many clients aren’t aware of fallen angels. Hence, they have adivsors and articulating the benefits of a fund like ANGL isn’t difficult. An obvious conversation starter is value. As in ANGL, though it’s a passively managed ETF, is able to astutely identify value to the benefit of investors.
“Downgrades often impact many companies in the same sector around the same time, if caused by a macro event,” adds Sokol. “That gets reflected in ANGL, which will typically go overweight a sector whose fundamentals have bottomed out and provide the potential for greater participation in a recovery. Similarly, it might avoid hot sectors where there may be increasing leverage, tight spreads and not a lot of downgrades, so ANGL is a contrarian strategy in many respects.”
Rising Rates Protection
As is often noted when it comes to bonds, clients have to give up something to get something. Those seeking interest rate protection often miss out on credit opportunities while those wanting higher yields will, in most cases, have to embrace either credit or rate risk.
That said, ANGL and its underlying benchmark have histories of thriving as rates rise and the fund offers that benefit with a 30-day SEC yield of 4.79%.
“There have been nine years since 2003 (which is when ANGL’s index launched) where rates have risen significantly (100 basis point yields or a Fed hike). Fallen angels outperformed the broad market in seven out of nine of those years,” concludes Sokol. “Similarly, fallen angels outperformed the broad market in the last two Fed hiking cycles, from 2004 to 2006, and from 2015 to 2019.”
Obviously, advisors know nothing is perfect. Certainly not in this fixed income climate, but fallen angels are credible options navigating income-starved clients through these perilous times.
Related: How to Preserve Credit Opportunities While Eliminating Rate Risk