Discovering Floating Angels in Financial Markets
A fallen angel, in the realm of investing, is a bond that was originally endowed with an investment-grade rating, but has since slipped into the depths of junk bond status following a deterioration in the financial health of its issuer. Additionally, the term can be extended to describe a stock that has experienced a dramatic fall from its peak.
Understanding Fallen Angels
Fallen angel bonds suffer downgrades from top rating services like Standard & Poor’s, Fitch, and Moody’s Investors Service. These can be corporate, municipal, or sovereign debt.
Key Takeaways
- A fallen angel is a bond reduced to junk status: The fall occurs when the issuer encounters financial trouble.
- Higher returns, higher risks: Fallen angel bonds offer greater returns compared to investment-quality bonds but they are more risky.
- Specialized Funds and ETFs: Certain bond funds and ETFs are dedicated to fallen angels bonds.
The primary catalyst for a downgrade is plummeting revenues, making it challenging for issuers to meet interest payments on their bonds. When declining revenues coincide with mounting debt, the likelihood of a downgrade skyrockets.
Fallen angel securities can appeal greatly to contrarian investors aiming to profit from a company’s potential recovery from a temporary lull. Downgrades generally commence with the debentures being placed on a negative credit watch. This forces many portfolio managers to divest, as their rules might prohibit holding downgraded bonds.
Market Dynamics: Junk Status and Selling Pressure
An outright downgrade to junk status intensifies selling pressure, particularly affecting funds confined to holding investment-grade debt. This scenario makes fallen angel bonds potentially valuable within the high-yield category, but only if issuers seem likely to bounce back from their troubled phase.
Dedicated Fallen Angel Funds
For those identifying value in discounted bonds, fallen angel bond funds serve as viable investment avenues. For instance, the VanEck Vectors Fallen Angel High-Yield Bond ETF invests solely in downgraden bonds. As of a specific date, it included holdings from companies such as Sprint Capital, Vodafone and Freeport McMoran. The iShares Fallen Angels USD Bond ETF, true to its name, invests in dollar-denominated fallen angel bonds.
Evaluating Risks in Fallen Angel Investments
Consider an oil company posting continuous losses for several quarters as oil prices fall. Its bonds, having lost investment-grade status and labeled as junk bonds, see their prices drop and yields surge. These bonds become attractive to contrarian investors viewing low oil prices as transitory.
However, some fallen angels' securities may never recover. For example, companies crushed by superior competitors often fail to bounce back if they cannot innovate. Transition examples from VCR tapes to DVDs to streaming services illustrate this threat.
Municipal or sovereign debt issuers may face downgrades as dwindling tax revenues and escalating debt levels create a vicious cycle hurting repayments and forcing more debt issuance. This eventually pushes entities towards default, validated by missed repayment schedules.
Related Terms: junk bonds, investment-grade bonds, credit ratings, high-yield ETFs, contrarian investing.
References
- VanEck. “VanEck Fallen Angel High Yield Bond ETF”.
- iShares. “iShares Fallen Angels USD Bond ETF”.
