While more are returning to the high-yield fixed-income market, investors can also take a look at a so-called fallen angel bond exchange traded fund to generate potentially more attractive risk-adjusted returns.
On the recent webcast, Not All High-Yield Bonds Are Created Equal, Wayne Schmidt, chief investment officer for Gradient Investments, outlines the current state of the fixed-income market, pointing out that interest rates remain low.
Schmidt argues that the Federal Reserve may be fettered in its ability to hike interest rates, with yields continue to be pressured by investors, low inflation, low wage growth and the slow economic growth. Looking over the short-term, he believes interest rates will remain low for the time being and the yield curve could continue to flatten.
Consequently, Schmidt suggests investors and advisors to capitalize on yield while they still can and overweight credit sectors and high-yield assets.
Fran Rodilosso, senior investment officer for Van Eck Global, also pointed out potential opportunities in the high-yield bonds, notably in fallen angel debt securities. For instance, the Market Vectors Fallen Angel High Yield Bond ETF (NYSEArca: ANGL) is the only ETF to specifically target the group of so-called fallen angel bonds. [Endorsing the Fallen Angel Bond ETF]
Fallen angels are corporate bonds that once held investment-grade credit ratings but, due to a variety of factors, were later downgraded to junk status. Fallen angel issuers tend to be larger and more established than many other junk bond issuers. Furthermore, since these fallen angels were formerly on the cusp of investment-grade status, this group of junk bonds typically has a higher average credit quality than many other speculative-grade debt-related funds.
“Relative to the broad high-yield bond market, fallen angels have historically averaged higher credit quality, higher absolute returns and higher risk-adjusted returns,” Rodilosso said.
The fallen angel bond ETF may also come with an embedded value characteristic. Before being included in the BofAML US Fallen Angel Index, a debt security that has been downgraded to speculative-grade status would have already experienced significant price deterioration.
ANGL’s risk profile includes 1.1% BBB-rated bonds, 73.5% BB, 17.3% B, 5.2% CCC and 0.5% CC. Due to its slightly higher quality profile, ANGL has a lower 4.7% 30-day SEC yield than other more junkier speculative-grade bond funds.
Moreover, fallen angel bonds have historically provided more attractive risk-adjusted returns than the broad high-yield bond market. Specifically, Rodilosso points to the 1.84 Sharpe Ratio from the BofAML US Fallen Angel Index, compared to the 1.27 Sharpe Ratio in the BofAML Original Issue High Yield Index and 1.11 reading from the Barclays High Yield Very Liquid Index – typically a higher Sharpe Ratio reflects a more attractive risk-adjusted return.
The fallen angel group has also outperformed over the past year. As of March 31, the BofAML US Fallen Angel Index has increased 7.2%, whereas the BofAML US High Yield Index gained 2.1%. The outperformance may be partly due to the higher credit quality and lower aveage energy sector allocations.
Financial advisors who are interested in learning more about high-yield bonds can listen to the webcast here on demand.
For more information on the speculative-grade debt market, visit our junk bonds category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.