Fixed-income investors who are wary about speculative-grade debt can look to the upper end of the junk bond market to generate attractive yields through a fallen-angel bond exchange traded fund.
For instance, the Market Vectors Fallen Angel High Yield Bond ETF (NYSEArca: ANGL) tracks so-called fallen angel, speculative-grade debt. ANGL is up 6.0% year-to-date. The fund has a 5.14% 30-day SEC yield.
“I think there’s a value proposition within fallen angels, which we talked about earlier,” Fran Rodilosso, senior investment officer for fixed-income ETFs with Van Eck, told Morningstar. “For investors who still want exposure to high yield but may be willing to give up some yield for the higher-credit-quality end of the spectrum, I think this is a good choice. Use it as a substitute or maybe an overweight within your high-yield allocation overall.”
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.
Rodilosso points out that fallen angels have remained in the BB category, so they remain in the higher-quality segment of the high-yield space. ANGL’s credit quality includes BBB 1.6%, BB 76.9%, B 14.0% and CCC 4.5%.
In contrast, popular junk bond ETFs, like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG), have a greater tilt toward lower-quality speculative-grade debt. HYG credit breakdown includes BBB 0.9%, BB 49.2%, B 40.0% and CCC 9.1%. [Taking a Second Look at High-Yield Bond ETFs]
With high-yield bonds, fixed-income investors are more worried about default rates. According to Edward Altman’s 30-year history of fallen angels, this fixed-income category has shown a percentage below the average annual default rate for original-issue high-yield bonds. Original-issue high-yield bonds have somewhere around a 4.5% annual default rates on average while fallen angels are closer to 3.6%.
High-yield default rates have also remained low over the past year, or below 1%. Moreover, the ratio of fallen angels becoming investment-grade again compared to original-issue high-yield is on the rise as well.
“So, they’ve defaulted less on average, historically, and ascended to investment-grade at a higher rate on average as well,” Rodilosso said.
Looking ahead, Rodilosso warned that the fallen angels category has a higher sensitivity to changes in interest rates than most speculative-grade debt. Fallen angels typically have longer durations since many were originally investment-grade and issued with longer than 10-year maturities. ANGL has a 5.57 year duration.
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.