Fallen Angel ETFs Return 7% and Have Outperformed – But Come With Risks

There is a segment of the bond market that is often overlooked by investors – and it is currently outperforming. These bonds are known as “fallen angels,” meaning those that have recently been downgraded from investment grade to high yield. Only two exchange-traded funds invest in this area: the iShares Fallen Angels USD Bond ETF (FALN) and the VanEck Fallen Angel High Yield Bond ETF (ANGL). The former has a 30-day SEC yield of 7.18%, while the latter has a 30-day SEC yield of 6.87%. Many institutional investors are forced to sell the bonds once they are no longer rated as an investment by credit rating agencies such as Moody’s and Standard & Poor’s. So there’s an imbalance between supply and demand, which pushes prices down in the short term, said Zachary Evens, research analyst at Morningstar. In fact, a 2019 report from the Chartered Alternative Investment Analyst Association found that bonds that enter the Bloomberg Barclays US High Yield Fallen Angel 3% Capped Index are valued 150 basis points cheaper, on average, than their counterparts. high efficiency. This can represent an opportunity for investors. “Over time, as supply and demand return to balance, this gap will narrow, helping these bonds outperform during this interim period,” Evens said. Tracking Outperformance Both FALN and ANG are part of Bank of America’s dynamic conservative yield strategy, which the bank describes as bonds with more exposure to the real economy and less exposure to inflation and rate risks of interest. The strategy better back-tested absolute and risk-adjusted returns, according to Bank of America. This year, conservative yield sector ETFs, as a group, outperformed the U.S. bond index by 3.5% on average and Treasuries by 9.3% on average, said analyst Jared Woodard in a note Monday. Fallen Angels, in particular, are 3.2% above the 10-month moving average, he said. FALN 1Y Mountain One-Year Performance of the iShares Fallen Angels USD Bond ETF The iShares Fallen Angels USD Bond ETF and the VanEck Fallen Angel High Yield Bond ETF track two different indexes. ANGL seeks to track the ICE US Fallen Angel High Yield 10% Constrained Index, while FALN tracks the Bloomberg Barclays US High Yield Fallen Angel 3% Capped Index. “[FALN] has traditionally outperformed high yield and investment grade securities over time,” said Stephen Laipply, global co-head of iShares fixed income ETFs at BlackRock. Historical data shows that the Bloomberg Barclays US High Yield Fallen Angel 3% Capped Index has recorded annualized returns over the past. 10 years of 7.25%, as of March 31, according to BlackRock. By comparison, the Bloomberg US High Yield Index has an annualized return of 4.64% over the past 10 years, the company said. The corporate bond index has an annualized return of 2.85% over 10 years. Be aware of the risks. Fallen Angel portfolios are generally much higher quality than their high-yield peers, Morningstar’s Evens said. About 70% of bonds are rated just below investment grade. BB. In the high-yield category, about 45% of bonds are rated BB, he said. However, there may be a risk of further credit downgrades, Laipply said: “If they were initially downgraded, there could be fundamentals. business that may continue to deteriorate,” he said. Conversely, about 25% of fallen angels revert to investment grade over time, Laipply noted. These bonds also typically have a longer duration than their high-yield counterparts, meaning there could be interest rate risk. FALN currently has a duration of 4.88 years, while the iShares Broad USD High Yield Corporate Bond ETF (USHY) has an effective duration of 3.33 years as of March 31. That said, duration and quality don’t matter as much to overall performance and risk, Evens said. market, short-term price collapse and resulting appreciation is what really affects the overall performance of funds in this category, he added. volatile despite higher credit quality than its high-yield peers,” Evens said, noting that volatility leans more toward a low-volatility stock fund than a core bond fund. “If you compare it to other bond funds, it is certainly much riskier and will likely give investors unwanted surprises during market corrections,” he added. For example, in 2020, fallen angel funds fell more than core bond funds and even the broad high-yield category, Evens said. Therefore, he suggests a small allocation to fallen angels to help give some juice to your portfolio, rather than a large allocation.

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