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Fallen Angels: A Better Way To High Yield?

ETF Professor

Entering this year, there were concerns about what the future held for high-yield corporate debt.

Fresh interest rate cuts by the Federal Reserve and an estimated $17 trillion in negative-yielding debt found around the world have prompted investors to revisit riskier corners of the corporate bond market.

What Happened

In recent years, junk bond ETFs have become alternatives, if not outright replacements, for individual issues among some high-level investors, explaining in large part substantial inflows to traditional junk bond exchange traded funds this year.

Investors would do well not to sleep on the VanEck Vectors Fallen Angel High Yield Bond ETF (NYSE: ANGL).

The $1.2-billion ETF tracks the ICE BofAML US Fallen Angel High Yield Index and holds 194 corporate bonds that were born with investment-grade ratings but were later downgraded to junk status.

Why It's Important

ANGL offers investors outperformance potential due to some elements of the corporate bond market of which only professionals are aware. 

“The market tends to anticipate rating actions, so bonds are typically sold and prices driven down prior to the downgrade. Historically, prices have tended to recover fully during the six months, on average, following the downgrade,” VanEck said in a recent note.

“This forced selling phenomenon and the higher quality tilt have driven long-term outperformance of fallen angels versus the broad high yield market.”

Another ingredient in the fallen angel secret sauce is embracing issues from sectors that are close to or already have bottomed out.

“Downgrades are often concentrated in certain sectors, which allows a fallen angel strategy to be overweight oversold sectors where fundamentals have bottomed out, and benefit from a potential recovery,” according to VanEck.

“The result has been an average of 250 basis points of outperformance versus the broader U.S. high yield market per year over the past 10 years, including outperformance in 11 of the last 15 calendar years.”

What's Next

ANGL is living up to its standard of outperformance this year, topping the largest traditional junk bond ETF by 260 basis points while being only 50 basis points more volatile.

Assuming ANGL keeps up its trajectory, 2019 would mark the sixth year in the past seven that it has topped the largest high-yield ETF.

“Since inception, ANGL has outperformed its Morningstar category average by over 300 basis points, as of 9/30/19, placing it at the top of the category,” notes VanEck.

“It has also outperformed active high yield bond strategies as measured by the Morningstar High Yield Bond category average over the same time period.”

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