Speculation is intensifying that the Federal Reserve will lower interest rates. It might do so by perhaps as much as 50 basis points, when it meets next month. The predictable result of that chatter is that advisors and investors are revisiting bonds. They’re evaluating which corners of the fixed income market are most likely to thrive when rates fall.
One of the answers to that question is fallen angel bonds. Those are corporate bonds that were born with investment-grade ratings that were later downgraded to junk. That asset class is accessible via the VanEck Fallen Angel High Yield Bond ETF (ANGL). That’s the original exchange traded fund dedicated to fallen angel debt.
The $3.01 billion ANGL carried a 30-day SEC yield of 6.54% as of Aug. 14. That’s certainly high enough to be positively correlated to interest rate reductions. However, there’s more to the story. Financial market history isn’t guaranteed to repeat. But it’s worth noting fallen angels have established track records of delivering upside following Fed rate cuts.
ANGL Matters Now
Prior to 2022, interest rates were low for prolonged periods of time. That means the number of legitimate easing cycles since the start of this century is low. To be precise, it’s two. One commenced in September 2007 and another in August 2019. However, that history, albeit limited, bodes well for ANGL.
“Fallen angels outperformed broad high yield over various time periods following the first rate reduction (see chart below), with spreads widening over the following months after the first cut as the economy experienced a slowdown/recession,” noted Nicolas Fonseca, product manager at VanEck. “Note that those cuts occurred under varying economic and market conditions. But we believe that in the current cycle, the higher quality and differentiated sector exposure may be drivers of outperformance going forward, as they have in the past.”
Better Risk-Adjusted Bet
Over the past three years — a period including the start of the Fed’s tightening cycle — ANGL was more volatile than the Bloomberg U.S. Aggregate Bond Index (“the Agg). That’s not surprising. But ANGL was the better risk-adjusted bet over that period, gaining 2.4% while the Agg slid 5.7%.
Another example of fallen angels’ favorable history is that these bonds tend to outperform in the period following the last rate hike leading up to the first cut. That was the case in 2007 and 2019.
“In both cases, fallen angels outperformed by an average of 0.80%. From the last hike to the first cut (June 2006 to September 2007 and December 2018 to August 2019), both strategies posted double-digit returns. [Fallen angels led] by 0.71% on average,” added Fonseca. “In contrast, from the last hike to the last cut (June 2006 to December 2008 and December 2018 to March 2020), broad high yield posted negative returns in both periods. [Fallen angels] achieved positive returns in the latter period.”
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