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This Bond ETF Could Regain Its Angelic Status

ETF Professor

Amid fears of rising interest rates in the U.S. and talk that default rates are climbing, some bond market experts expected a rough year for high-yield corporate debt.

While there have been ample warnings regarding the health of the junk debt market, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSE: HYG), the largest junk bond exchange trade fund, is up half a percent year-to-date. Conversely, the VanEck Vectors Fallen Angel High Yield Bond ETF (NYSE: ANGL) is lower by 1.1 percent.

What Happened

Over much of its more than six years on the market, ANGL has outperformed traditional junk bond benchmarks with less volatility due in part to the fact that fallen angels are high-yield bonds that were born as investment-grade fare.

“Fallen angel bond performance is mainly driven by higher average credit quality, sector differentiation, and potential value from discounted bonds as they are downgraded to high yield status,” said VanEck in a recent note.

Over 95 percent of ANGL's holdings are rated BB or B. By comparison, the Markit iBoxx USD Liquid High Yield Index allocates 87 percent of its weight to bonds with those ratings.

Why It's Important

Sector allocations are an important factor with fallen angels, particularly for bond investors monitoring developments in the oil market.

“Top fallen angel sector contributors year to date have been the overweight in energy and underweight in media,” said VanEck. “Main detractors have been positions and overweights in the basic industry (e.g., materials) and telecom sectors.”

As of May 31, energy was ANGL's largest sector allocations at 24.6 percent. The ETF's 30-day SEC yield is 5.61 percent, slightly below the 30-day SEC yield on HYG.

What's Next

ANGL devotes just 3.59 percent of its weight to highly speculative CCC-rated bonds. While those bonds are outperforming this year, the credit risk premium on that debt is declining, indicating that speculative-grade junk bonds are potentially overvalued and due for a correction.

“While not always the case, fallen angel bonds have tended to outperform the broad high yield bond market, on average, in calendar years when credit spreads widened meaningfully, as well as in the subsequent recovery periods,” said VanEck.

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