Fallen Angels: New Downgrades End Seven Month Drought

Fallen angels (as represented by the ICE US Fallen Angel High Yield 10% Constrained Index, “H0CF”) underperformed the broad high yield market (as represented by the ICE BofA US High Yield Index, “H0A0”) in September by 0.35% (1.28% vs. 1.63%), as lower quality bonds continued to outperform. This extended fallen angels’ Q3 underperformance to 0.23% (5.05% vs. 5.28%) and widened the YTD performance gap to 1.84% (6.18% vs. 8.03%). One of the key trends supporting high yield performance has been the outperformance of lower-rated bonds. The CCC & Lower-rated index has returned an impressive 15.35% YTD, compared to 7.19% for Single-B and 6.82% for BB-rated bonds. The higher quality exposure that is characteristic of fallen angels (87% BB vs 54% in the broad high yield market) has been a headwind in terms of relative performance. In September, the fallen angel index had two new entrants: OCI NV and VF Corp, which were downgraded to high yield, adding approximately $2.4bn in face value to the Index, while in early October, S&P placed Boeing on negative watch as approximately 33,000 workers remain on strike.

In mid-September, the U.S. Federal Reserve (Fed) cut interest rates by 0.50%, bringing them to a range of 4.75%–5.00%. This marked the first rate cut in four years, reflecting progress toward the Fed’s 2% inflation target and indicating signs of softening in the labor market. While credit conditions have remained robust overall, the upcoming November elections and ongoing geopolitical risks in the Middle East could lead to heightened volatility in the coming months.

Fallen Angel Positioning for Q4 2024

Fallen angels offer a distinct value proposition within the high yield market. Since the pandemic, they have maintained higher quality, with over 80% of fallen angels rated BB, compared to approximately 50% for the broader high yield market. However, sector exposures have shifted significantly. Earlier this year, we highlighted Real Estate and Banking as key sectors to watch due to their overweight positions in fallen angels, offering attractive spreads and higher yields. These sectors have delivered positive performance, behind only Telecom, which was the highest contributor in both Q3 2024 and YTD.

Looking ahead to Q4, we continue to see Banking and Real Estate as sectors of interest, with overweights of 4.65% and 5.99%, while offering wider spreads (7bps and 110bps) and higher yields (48bps and 90bps), respectively. We are keeping a close eye on Capital Goods and Media, as downgrades of large issuers Boeing and Paramount have the potential to alter sector dynamics. Lastly, Retail and Telecom are significantly overweight in the fallen angel index by 15.53% and 6.24%, respectively.

Sector Allocations: Fallen Angel US High Yield vs. Broad US High Yield (As of 9/30/2024)

Source: ICE Data services and VanEck.

Fallen Angels Overall Statistics: Fallen angel yields continued their downward trend, ending the month at 6.43%. This marked the first time since the summer of 2022 that yields finished below 6.50%. The average price of fallen angels rose to $93.69, narrowing the gap relative to the long-term average, although remaining about $1.50 below that level. This reflected the broader trend in the high yield market, where average yield declined by 36bps to 6.98% and the average price increased to $96.72. We also note the shrinking yield differential between fallen angels and the broad high yield market. As of the end of September, the spread had narrowed to just 0.55%, its lowest level since the summer of 2021. This narrowing gap has occurred despite the stability of the overall credit quality of both markets, with the main driver being the compression of CCC and below spreads. The fallen angel index saw its largest market value increase in recent months, boosted by the addition of two fallen angels.

Source: ICE Data Services, VanEck. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Broad HY: ICE BofA US High Yield Index. OAS refers to “option-adjusted spread.” Please see definition for this and other terms referenced herein in the disclosures and definitions portion of this blog. Past performance is no guarantee of future results. Index performance is not representative of strategy performance. It is not possible to invest in an index.

Fallen Angels: The seven month drought of fallen angles ended in September as OCI NV and VF Corporation were downgraded to high yield, adding approximately $2.4bn in face value to the index. OCI NV senior unsecured notes were downgraded to Ba1 from Baa3 by Moody’s as a result of multiple divestiture announcements by the company, which Moody’s believes will greatly diminish its scale and business profile. VF Corporation was also downgraded to Ba1 from Baa3 by Moody’s, reflecting a weaker credit profile as it transforms its business with various initiatives. We continue to watch for any action by Moody’s on Paramount following its current review, as well as any additional rating actions on Boeing following S&P placing it on negative watch. S&P stated that their action reflects the possibility of a downgrade if the strike continues towards the end of the year, as Boeing will likely incur a cash outflow of $10bn and require additional funding. Two downgrades are needed for Boeing to become a fallen angel eligible for index inclusion.

Rising Stars: Port of Newcastle Investments Financing was upgraded by S&P to BBB- from BB+ on stronger financials, joining Delta Air Lines as the only rising stars in Q3. It was downgraded to high yield exactly one year ago, September 2023, entering the fallen angel index at $82.79 and exiting at $95.59, providing a 15% price return.

Source: ICE Data Services, VanEck. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Past performance is no guarantee of future results. Not a recommendation to buy or sell any of the names/securities mentioned herein. Index performance is not representative of strategy performance. It is not possible to invest in an index.

Fallen Angels Performance by Sector: Basic Industry and Retail saw their exposure increase with the addition of OCI NV and VF Corporation. Basic Industry is now just shy of a 5% exposure while Retail jumped to close to 22% and continues to be the top sector exposure within fallen angels. Aside from these two sectors, there were no major shifts for Q3. In terms of spread, the Transportation sector saw 71bps of tightening, the largest of all sectors, while its price jumped by over 8%. Fallen angel spreads saw some volatility in Q3, as they reached 310bps in early August, but overall have been trending down so far this year. Real Estate spreads remain volatile and display the highest spreads of all sectors. September is the first month since February 2023, when the Banking sector was slightly above par (right before the mini-crisis) where various sectors have seen their price above par, but unfortunately this was not enough to outperform broad high yield. Regarding sector attribution vs broad high yield for Q3 and YTD, the lack of Media exposure, alongside limited exposure to Services and Basic Industry, have been detractors to performance while Telcom, Banking and Real Estate continue to be contributors.

Source: ICE Data Services, VanEck. Returns are based on partial period data. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Not intended as a recommendation to invest or divest in any of the sectors mentioned herein. Index performance is not representative of strategy performance. It is not possible to invest in an index.

Fallen Angels Performance by Rating: No significant changes in the fallen angels rating allocation for September, however, the Real Estate sector had two one-notch downgrades: Hudson Pacific Properties to BB3 from BB2 and Service Properties Trust to B3 from B2. In terms of performance vs broad high yield for September, Q3 and YTD, higher quality (BB) has positively contributed to performance but lower quality (Single-B and CCC & Below) have significantly detracted. The CCC & Below index is up 15.35% so far this year, with most of the performance coming in Q3.

Source: ICE Data Services, VanEck. allen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Not intended as a recommendation to invest or divest in any of the sectors mentioned herein. Index performance is not representative of strategy performance. It is not possible to invest in an index. BB index: ICE BofA BB US High Yield Index; Single-B index: ICE BofA Single-B US High Yield Index; CCC & Lower rated index ICE BofA CCC & Lower US High Yield Index. ^*Doesn’t have securities for all months of selective periods. Returns are based on partial period data.