With two interest rate hikes by the Federal Reserve in the books and more on the way, to say this is a tumultuous time in the fixed income market may be an understatement.
High yield corporate bonds are incurring plenty of bond sellers’ wrath and casting a pall over previously attractive exchange traded funds, including the VanEck Vectors Fallen Angel High Yield Bond ETF (NASDAQ: ANGL).
ANGL, which tracks the ICE US Fallen Angel High Yield 10% Constrained Index, sports a 30-day SEC yield of 5.83% — definitely high yield territory. More importantly, its status as the largest dedicated fallen angel fund is relevant because fallen angels aren’t typical junk bonds, many of which are faltering this year against the backdrop of Fed tightening.
“Fallen angels average higher credit quality as compared to other junk bonds and original-issue junk bond indexes. About 75% of the bonds in the fallen angel category are BB-rated and, therefore, have a lower credit risk. The average 12-month default rate for fallen angels is 3.51%. This compares favorably to 4.51% of original-issue high yield bonds and 4.22% for high yield bonds overall,” according to the Corporate Finance Institute (CFI).
What sets fallen angels apart, including ANGL components, is that these bonds are issued with investment-grade ratings and are later downgraded to junk status. That plays a pivotal role in the aforementioned superior credit quality and default rates, and as a result of those two enviable traits, fallen angels typically outperform standard high yield corporate debt over long holding periods.
“Although the downgrade may be viewed as a negative, fallen angels are attractive to contrarian investors who want to capitalize on the entity’s ability to recover. They are considered higher-quality bonds than the average high yield bonds, as they have the potential of bouncing back to investment grade. Fallen angel issuers are usually larger, more mature companies with well-known brand names. Thus, they usually have the resources to help them bounce back to investment grade,” added CFI.
The $3.4 billion ANGL holds 220 bonds, 85.52% of which are rated BB. ANGL’s duration is 5.81 years. That’s intermediate-term territory, which could indicate that the fund’s 2022 struggles are too severe because this clearly isn’t a longer-dated fixed income fund. Additionally, that intermediate-term status is a point in favor of portfolio diversification because bonds with that type of duration are usually less correlated to equities than longer-dated fare.
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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.