With interest rates and, perhaps equally as important, default rates low, it's not surprising that investors are displaying some enthusiasm for high-yield corporate debt this year. Through the end of November, inflows to fixed income ETFs were outpacing those to rival equity funds for the first time in over a decade and junk bond funds are getting in on the act.
The two largest traditional high-yield corporate bond funds have hauled in nearly $7.6 billion in new assets combined this year and investors have been rewarded for their faith in those product as that junk duo has returned an average of 9.20% year-to-date.
However, bond investors could be doing even better with the VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL). ANGL, which is moving to Nasdaq later this month, focuses on an often overlooked segment of the high-yield bond universe known as fallen angels, as the fund's name implies.
The premise behind fallen angels is simple. They're corporate bonds that were born with investment-grade ratings and were later downgraded to junk status. For those that are in school or with kids in school, think of fallen angels as former honor roll students that lose their way. Good news: as is the case with students, fallen angel bonds can regain their lost luster and deliver impressive results.
ANGL is proving as much in 2019. With comparable volatility to the aforementioned standard junk bond ETFs, ANGL is higher by 12.50%, providing significant out-performance of its prosaic rivals.
Why ANGL Matters
As an investment factor, value is often discussed in equity terms, but it has myriad applications in the bond space as fallen angels confirm.
ANGL's “differentiating characteristics versus the broader high yield bond market—such as, a higher average credit quality—and the crossover from investment grade to high yield markets is where the value proposition of fallen angels originates,” said VanEck in a recent note.
Of course, credit risk is the primary concern with ANGL, as it is with any other junk bond fund. To that end, the fund devotes barely more than 7% of its weight to CCC-rated bonds, the most speculative fare in the junk bond space. There are times when CCC exposure is efficacious, but this year isn't one of those times.
“The bonds of companies rated CCC+, CCC, and CCC-, the three lowest ratings before default, have been underperforming the broader junk bond market all year,” according to Barron's. “That matters because lower-rated debt is considered to be most sensitive to economic growth. And normally, when high-yield bonds are rallying the way they have this year, the CCCs rally as well. So at best, their underperformance signals widespread investor caution about risky credit.”
One way of looking at that scenario is an investor doesn't want to be involved with CCC bonds during an economic slowdown or an outright recession. Speaking of cyclicality, corporate credit downgrades are often concentrated in lagging sectors, some of which are late-cycle plays offering value.
“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.”
ANGL has some of that cylical/value tilt as 34.40% of its 198 holdings hail from the energy and materials sectors.
Not A One Hit Wonder
ANGL's durability in 2019 isn't a fleeting phenomenon. Over the past three years, the fund has outpaced the two biggest junk bond ETFs by an average of 180 basis points with roughly the same amount of volatility.
Past performance is never a guarantee of future results, but history does suggest that selling fallen angels after those bonds attain that status is rarely a good idea.
In fact, because issuers have tasted the “good life” of investment-grade territory, they're likely to make moves to get back to the promised land or, at the very least, avoid further downgrades.
ANGL yields 5.17% and with its low CCC exposure, it's a fund income-starved investors may want to consider.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Todd Shriber
Todd Shriber got his start in financial markets as a reporter with Bloomberg News. Later, he became a trader at a Southern California-based long/short hedge fund where he specialized in trading sector and international ETFs leading up to and during the financial crisis. He would later become the web editor at ETF Trends. Currently, he analyzes, researches and writes on ETFs for a variety of Web-based publications and financial services firms.Shriber has been quoted in the Barron's, CNBC.com and the Wall Street Journal. His work has been published on Web sites such as Benzinga, ETF Daily News, ETF Trends, MarketWatch, Fox Business and Nasdaq.com.
Read Todd's Bio