Fallen angels : the essential high yield overweight? | Insight Investment

We believe a systematic approach to high yield may offer advantages over both active and passive approaches.

Fallen angels currently offer higher credit ratings

75% of US fallen angels¹ have a BB rating. This is higher than both the ‘broad high yield’¹ and ‘liquid high yield’¹ markets (Figure 1).

Figure 1: Fallen angels currently offer higher credit quality than broad high yield and liquid high yield indices¹

Fallen angels have offered higher total returns

Despite higher average credit ratings, fallen angels have delivered higher returns than the broad high yield market.

Since the high yield fallen angel index was launched in 2005, this category has outperformed both the broad high yield and liquid high yield categories over every 5-year period on a rolling monthly basis. However, this does come with some additional volatility versus the broad high yield market, which can be attributed to the lower level of diversification in fallen angels.

Fallen angels have nonetheless outperformed the liquid high yield index in both risk and return terms (Figure 2). This liquid high yield index is often the favoured index tracked by high yield ETFs. Fallen angels have outperformed the broad high yield and liquid high yield categories 100% of the time on a monthly rolling 5-year basis since the fallen angel index launched in 2005¹.

Figure 2: Fallen angels have delivered higher returns than the broad high yield market and higher risk-adjusted returns than the liquid high yield market²

Fallen angels have historically outperformed during periods of rising rates

Although fallen angels are, on average, higher duration with greater sensitivity to interest rate changes, through the last four rising rate environments (where 10-year Treasury yields have risen by 1% or more) they have outperformed the broad and liquid high yield indices.

This is generally because rates tend to rise when the economy is improving.  While fallen angels are impacted by rising yields, the positive contribution made by credit spread tightening at the same time has typically more than compensated for this (Figure 3).

Figure 3: Fallen angels have outperformed in rising rate environments, despite additional duration sensitivity²

Improving economic conditions have historically favored fallen angels

Fallen angels have historically seen stronger credit spread performance than the broad and liquid high yield markets over the last 5-years and since inception of the fallen angels index in 2005. This has compensated for slightly lower duration returns (Figure 4).

Figure 4: Excess income over Treasuries and tightening credit spread has driven the relative outperformance of fallen angels²

Fallen angels have outperformed broad high yield during high downgrade years

Historically, fallen angels have also tended to outperform the broad and liquid high yield markets by significant margins during periods of high downgrade activity. During other periods, fallen angels have also fared well against the other indices albeit with less of an outperformance margin over them (Figure 5).

Figure 5: Fallen angels have delivered solid performance through difficult markets²

We believe a strategic allocation to high yield reflecting an emphasis on fallen angels can reap rewards for long term investors

We believe that high yield credit offers value as a strategic allocation given the historical risk-adjusted returns exhibited in both benign and more challenging market conditions. 

We also believe that an emphasis on fallen angels within this can enhance a high yield investment strategy, especially for investors able to access liquidity in this specialist fixed income sub-asset class.