Investors looking into high-yield bonds to augment their fixed-income portfolio may consider a fallen angel speculative-grade debt-related exchange traded fund.
On the recent webcast, Fine Tune Your High Yield Strategy, Francis Rodilosso, Portfolio Manager at VanEck, explained that recent and potential sector growth will contribute to support fallen angel bonds and related VanEck Fallen Angel High Yield Bond ETF (NYSEArca: ANGL), which tracks so-called fallen angel speculative-grade rated debt, or debt securities that were initially issued with an investment-grade rating but were later downgraded to junk territory.
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, the group of junk bonds typically has a higher average credit quality than many other speculative-grade debt-related funds.
Related: A Smart-Beta, High-Yield ETF Strategy for Quality
Rodilosso said that fallen angel bonds offer a potential value play as the debt securities typically experience a steep sell-off from institutional forced selling prior to being added to the fallen angels group. Looking ahead sector themes can help support potential price appreciation. Additionally, the groups’ higher average credit quality can help diminish market volatility.
Investors have kept an eye on high-yield bonds as credit spreads remain above historical 615 basis point average since mid-November, with 50% of U.S. junk bonds trading below par.
[related_stories]The commodity price collapse, notably in crude oil, has weighed on the junk bond market, but the damage may be limited to lower credit quality.
On the other hand, investors who focused on fallen angel bonds may have witnessed less volatility. Relative to the broader high-yield market, fallen angels have historically included greater concentration of higher quality or BB-rated speculative-grade bonds. However, potential investors should keep in mind that while fallen angels have a higher quality tilt, the group comes with a lower average yield and higher average duration – the Fallen Angel ETF has a 6.43% 30-day SEC yield and a 5.71 year duration.
Rodilosso also pointed out that over the past 12 months, fallen angel growth has primarily come out of energy and basic industry issuers. So far this year, stabilizing commodity prices have helped bolster energy and basic industries.
Related: Rising Corporate Defaults Could Keep a Lid on Junk Bond ETFs
On a survey of advisors participating on the webcast, 40.7% of respondents revealed they prioritize credit quality and 49.6% look for performance. ANGL leans toward higher quality speculative-grade debt, including low investment-grade BBB 6.5%, along with speculative-grade BB 75.8%, B 9.5%, CCC 3.7%, CC 0.1% and non-rated 2.9%. Additionally, the ETF has been among the best performing high-yield funds, rising 12.8% year-to-date.
Looking ahead, the majority of surveyed respondents believe Federal Reserve rate hikes will be the greatest risk to credit markets for the rest of the year. Rodilosso outlined three possible scenarios that fixed-income investors should keep in mind. If the Federal Reserve acts on a tightening labor market and rising core inflation, high yield credit spreads could tighten. If U.S. growth slows, corporate credit could disappoint. Lastly, if the Federal Reserve acts with a slow and steady hand, high-yield debt could continue to perform.
For more information on speculative-grade debt, visit our junk bonds category.
Financial advisors who are interested in learning more about the speculative-grade debt market can watch the webcast here on demand.