Why High-Yield Investors Should Consider Fallen Angel Bond ETFs

As many look to fixed-income markets ahead, ETF investors may consider a strategy that could help enhance yield opportunities in a diversified bond portfolio.

On the recent webcast, Why Not All High Yield Bonds are Created Equal, Fran Rodilosso, Head of Fixed Income ETF Portfolio Management, VanEck, and Dan Cupkovic, Director of Investments, ARGI Investment Services, argued that fallen angel bonds may be a better way for fixed-income investors to enhance yields and diversify away from potential risks in the broader high-yield bond market.

Rodilosso explained that fallen angels are bonds originally issued with investment grade ratings and subsequently downgraded to high yield. Relative to the broad high yield bond market, fallen angels have historically averaged higher credit quality, higher absolute returns and higher risk-adjusted returns.

Due to their greater focus on credit quality in the high-yield segment, fallen angels provide greater diversification for traditional junk bond investors. For example, fallen angels outperformed in 2014 due to a lower energy sector allocation compared to the broad high-yield bond market, and they also outperformed in 2016 after adding discounted energy and mining sector names.

Since fallen angels cover issued debt that were once investment-grade rated, this segment historically provided higher exposure of BB-rated bonds and lower exposure to lower rated bonds relative to the broad high yield bond market. Cupkovic noted that fallen angels will have a greater tilt toward higher quality “gentleman’s” junk type exposure. Specifically, the ICE BofAML US Fallen Angel High Yield Index shows a 77% tilt toward BB-rated debt, followed by 19% B-rated and 5% C-rated. In comparison, the ICE BofAML US High Yield Index has 49% BB-rated, 40% B-rated and 11% CCC-rated.

The fallen angels have also exhibited an average historical default rate lower than that of bonds rated speculative grade upon issue.

Since the end of 2003 through August 2019, fallen angels have on average historically outperformed the broad high yield bond market and active high yield bond fund managers. Fallen angels outperformed the broad high yield bond market 11 of the last 15 calendar years, including 7 of 9 calendar years when interest rates rose more than 1%. In 2019 alone, fallen angels have outperformed the broad US high yield market by 1.6%, driven by credit selection. Specifically, the fallen angels index has capitalized on its grater tilt toward basic industry, banking, technology and telecommunications.

As a way to tap into the fallen angels segment, investors may look to the VanEck Fallen Angel High Yield Bond ETF (NYSEArca: ANGL), which tries to reflect the performance of the ICE BofAML US Fallen Angel High Yield Index and comes with a 0.35% expense ratio.

Financial advisors who are interested in learning more about the high-yield bond market can watch the webcast here on demand.