Van Eck continued a recent trend of expansion in the junk bond ETF space today with the launch of a product that targets a unique segment of the high yield bond market. The new Market Vectors Fallen Angel High Yield Bond ETF (ANGL) will focus on debt that was originally rated as investment grade quality at the time of issuance. In other words, the component securities were once deemed to be of relatively low credit risk, but have since been downgraded to “junk” status.
Most ETFs in the High Yield Bonds ETFdb Category don’t screen based on the rating status at the time the bond was issued, focusing instead on the current credit rating assigned. ANGL, which seeks to replicate the BofA Merrill Lynch US Fallen Angel High Yield Index, will include bonds that have fallen out of favor with investors since they were first floated, perhaps because of deteriorating conditions and cash flow prospects in the underlying business.
Because credit downgrades–especially those from investment grade status to junk status–are negative developments, so-called “fallen angel” bonds may represent an opportunity to buy in after a significant decline in price. While there is obviously considerable risk involved–the bonds were downgraded for a reason–there’s also an opportunity if prices recover and these securities return to investment grade status. Fallen angel bonds tend to be concentrated at the higher end of the junk bond credit quality spectrum.
Downgrades from investment grade to junk status often results in “forced selling” of a security by institutions who aren’t permitted to hold certain types of bonds (e.g., junk bonds). That can create an opportunity to purchase these securities at a discount to their intrinsic value.
Under The Hood
Fallen angel junk bonds tend to be large, established companies, whereas lower-rated junk bonds can be issued by smaller and more speculative firms. The ANGL portfolio includes a number of issuers that fit that description, such as Ford Motor Company, Citigroup, and Nextel Communications.
|Average Yield to Worst||7.48%|
|Average Modified Duration||5.49|
|Average Years To Maturity||10.05|
|Number of Holdings||396|
The underlying index consists of about 400 individual bonds, with an average duration of about 5.5 years. The component bonds have an average coupon of about 6.8% and an average yield to worst of 7.5%.
About a third of the ANGL portfolio consists of financials companies, with industrials bonds accounting for the bulk of the remainder. Within that industrials bucket, exposure is spread across about a dozen different sectors such as automotive (6%), real estate (2%), telecom (14%), energy (9%), and consumer cyclicals (7%).
Bonds rated BB, the highest rating for junk bonds, make up about 72% of the portfolio. “B”-rated debt makes up another 19%, meaning that the bulk of the ANGL portfolio has a rating relatively close to investment grade status. The iShares iBoxx $ High Yield Corporate Bond Fund (HYG), the most popular junk bond ETF with about $14 billion in assets, has about 43% of its portfolio rated BB and another 41% with B ratings [see the ANGL fact sheet].
Junk Bond ETF Boom
The last several weeks have seen a dramatic expansion in the number of ETFs available to U.S. investors looking to target junk bonds, with many of the recent additions to the ETF lineup targeting international bonds. Van Eck recently rolled out an International High Yield Bond ETF (IHY) that targets junk bonds outside the U.S. iShares has also been active in expanding its junk bond ETF lineup, launching multiple products targeting international junk bonds:
There are now 16 different ETFs in the High Yield Bonds ETFdb Category, including several target maturity date products from Guggenheim and an actively-managed ETF (HYLD) from AdvisorShares. These ETFs have aggregate assets of nearly $30 billion, highlighting the significant interest in this asset class.
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Disclosure: No positions at time of writing.