The Angelic ETF Way to High Yield Bonds

ETF Trends

Sometimes, people deserve a second chance. Perhaps the same is true of bonds, particularly the high-yield variety, with the second chance being another crack at an investment-grade rating.

That is what the 106 holdings of the Market Vectors Fallen Angel High Yield Bond ETF (ANGL) aspire to: Another shot at investment-grade status. ANGL’s holdings are junk bonds that were originally issued with an investment-grade rating. [A Value Bet on Unique Junk Bonds]

Due to the once upon a time investment-grade status of its holdings, ANGL’s profile is tidier than other high-yield bond ETFs with nearly three-quarters of the fund’s weight rated BB. Investors are still compensated with a 30-day SEC yield of almost 4.2%. That compares to 4.38% for the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) .

Importantly, ANGL and the fallen angels it holds have the look of value bets.

“Fallen angel bonds, high-yield bonds that were originally investment-grade issues, warrant further distinction for an embedded value proposition that is not common to all of high yield,” said Market Vectors Portfolio Manager Fran Rodilosso in an email to ETF Trends.

Fallen angels represent just 13% of the overall high-yield universe, that does not diminish the angels’ out-performance potential.

“For 7 out of the last 10 calendar years, fallen angel high-yield bonds have outperformed the broad high-yield bond market, including original issue high-yield bonds. Year-to-date, as of July 21, 2014, fallen angels have kept pace with the last two years, having outperformed the broad high-yield bond market by nearly 300 basis points: 7.63% vs. 4.70%,” said Rodilosso.

The combination of decent-by-comparison credit profiles and their cast aside status helps make fallen angels a potentially potent value proposition. As Rodilosso notes, when corporate bonds are downgrade to junk from investment-grade status, many portfolio managers are forced to sell those bonds to keep their funds entirely allocated to investment-grade issues. [Spotlight on Fallen Angel Bonds]

ANGL and its holdings do, however, have sensitivity to interest rates.

“While currently yielding less than original issue high-yield bonds, mainly as a result of a relatively higher rated credit composition, a portfolio of fallen angels presents an interesting value proposition given the trends listed above. It should also be noted that, on average, fallen angels currently have higher interest rate sensitivity, a factor which contributed to their outperformance versus the broad high-yield bond market year-to-date 2014,” said Rodilosso.

ANGL has a modified duration of 5.61 years compared to an effective duration of four years on HYG. ANGL’s duration to worst is 5.55 years with a spread duration of 5.68 years, according to Market Vectors Data.

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Chart Courtesy: Market Vectors

Tom Lydon’s clients own HYG.

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