Anfield Fixed Income Update: May 2021
What is a ‘Fallen Angel’?
In Fixed Income, a Fallen Angel refers to a bond that was initially given an investment-grade rating but has since been reduced to high-yield (or junk bond) status. This downgrade is often caused by a deterioration in the financial condition of the issuer, or a broad deterioration in credit access or liquidity.
The downgrade process usually begins with the company’s debt being placed on a negative credit watch by one of the various rating agencies. This indicates the agency is pessimistic about the outlook for the issue or company as a whole. Once the credit receives the actual downgrade, it has “fallen” from the coveted investment-grade distinction and landed in the world of high-yield debt.
Why Does This Matter?
The actual downgrade from investment grade to high yield drives selling pressure, particularly from funds which are restricted to holding investment-grade debt exclusively. As a result of this, fallen angel bonds can present value within the high-yield category, but only if the issuer appears to have a reasonable chance of recovering from the conditions that caused the downgrade. Ultimately, through our intensive credit research we make an effort to determine whether those new opportunities are prudent to add and could benefit the strategies overall.
This is all particularly important given the last year and all the market turmoil that came with it. Throughout the outbreak of COVID and the resulting economic crises, a record number of issuers joined the fallen angel class as their liquidity and credit profiles were adversely affected from economic lockdowns, restrictions, and drastic changes in consumer behavior. However, as the effects of the COVID-19 pandemic and economic lockdowns are presumably temporary, this fallen angel bucket has received an increasing amount of investor attention, particularly as global yields and rates have remained at or near historical lows.
Where Are we Now?
Previous predictions from credit analysts put the amount of “fallen angel” in the range of $300 - $400bn for the next 12 to 24 months. However, as the impact of Fed actions on issuer’s liquidity positions and the reluctance of rating agencies to downgrade highly levered low-BBB issuers continue to show resilience, it is becoming clear this was a pessimistic and no longer realistic prediction.
As CreditSights put it, “The speed of the transition from dire predictions of fallen angel debt to anticipation of the next wave of rising stars has been breathtaking.” After having seen only $860mn of US investment grade fallen angel debt so far this year, and zero across Europe investment grade, the estimate for fallen angel debt now lies “well below $100 bn between now and the end of 2022.”
To recap, US investment grade fallen angel debt peaked in December 2020 at $260bn, driven largely by the energy sector, with volume heavily concentrated by issuer as just four issuers (Pemex, Ford, Occidental, and Kraft Heinz) accounted for almost 60% of 2020’s total. From May to December 2020, monthly US investment grade fallen angel volume averaged just $9bn, as rating agencies slowed to allow time for BBB corporates most impacted by the economic slowdown to improve liquidity and leverage. In a stark contrast to this period 1 year ago, the first four months of 2021 saw just one fallen angel from the energy sector, with $860mn of senior debt moving into the US high yield index.
Current Fixed Income Positioning
Sources: Morningstar, Bloomberg, Manager as of April 30, 2021
Universal Fixed Income Strategies: Benchmark agnostic and line-item bond security portfolios looking to highlight our best ideas in bond space.
Dynamic Bond strategy: Benchmark aware to the Bloomberg Barclay’s Aggregate Index and is a top-down macro-focused ETF of ETFs.
"Anfield Affection Gauges:"
What fixed income sectors & exposures do we like, and what do we dislike?
Long Duration Gov't Bonds LQC Mortgages Structured Products/CLO's HQC
Non-US FI LQC Gov't Bonds Mortgages HQC
LQC = Lower Quality Credit HQC = Higher Quality Credit
Current Fixed Income Positioning Definitions:
Duration represents the current value for each of the funds and indices noted
Curve represents where each of the funds and indices are positioned on the yield curve
Government represents the percentage allocated to Government bonds within the funds and indices
Credit represents the percentage allocated to Investment Grade and High Yield Credit within the funds and indices
MBS represents the percentage allocated to Mortgage-Backed Securities within the funds and indices
Yield (YTM) represents the Yield to Maturity of the funds and indices
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