Higher Yields and Tighter Spreads Drive Monthly Outperformance

Fallen angels (as represented by the ICE US Fallen Angel High Yield 10% Constrained Index, “H0CF”) outperformed broad HY (as represented by the ICE BofA US High Yield Index, “H0A0”) by 0.15% (1.78% vs 1.63%) in June and are now lagging by 0.55% year-to-date (YTD) (4.86% vs 5.42%). In June, bond selection and tighter spreads drove outperformance versus the broad high yield market. More broadly, CCC & lower rated bonds have continued to outperform higher rated peers as spreads have again tightened, and yields have increased. Although credit spreads rallied in June, forecasts for defaults in high yield have started to rise as the U.S. Federal Reserve (Fed) continues to maintain high interest rates while signaling additional tightening may be on the horizon.

Where to Now?

Amid strong economic data, the risk of a hard landing or recession appears to continue to be pushed further into the future than what the market anticipated earlier in the year. This has been reflected in high overall yields even though spreads have tightened. How have fallen angels performed historically when yields were at these levels?

• There have been 235 months since December 2003.
• The fallen angel yield has been above seven with spreads below 300 only 17 times during the 235 months since December 2003. The most recent two times was in February and June of this year.
• The remaining 15 times were in 2005 (twice), 2006 (seven) and 2007 (six).
  • The average forward 1Y returns in those 15 months saw fallen angels underperform broad high yield by 1.10% (2.76% vs 3.85%)
  • 3Y forward basis, fallen angels outperformed by 1.52% (5.55% vs 4.03%, annualized)
  • 5Y forward basis, fallen angels outperformed 1.77% (9.67% vs 7.91%, annualized)
  • 10Y forward basis, fallen angels outperformed by 2.74% (10.12% vs 7.38%, annualized)

Source: ICE Data Services, VanEck. Data as of June 30, 2023. 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 fund performance. It is not possible to invest in an index.

Fallen Angels Overall Statistics: Fallen angels yields decreased in June by 20bps, to 7.35, while broad HY yields decreased by 27bps to 8.56 and the 10Y yield increased by 17bps to 3.81. Fallen angels current yield has been in the 30th percentile since December 2003, while spreads are only in the 16th percentile, demonstrating that yields are high while spreads are very tight. With the exit of some large issuers over Q2, the Index market value has shrunk over the year.

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 fund performance. It is not possible to invest in an index.

New Fallen Angels: Seven issuers were downgraded in the first six months of the year, accounting for 11.18% of the Index. Per JP Morgan research, the “BBB-“ universe is $1.13 trillion with $131 billion on negative watch or outlook by at least one rating agency. Research on certain scenarios (an issuer with an already high yield rating by one agency; same issuer with at least one of the other agencies rating it on negative watch/outlook) determined that only $6.7 billion may be downgraded in the near term. However, the research also identified the number of non-financials “BBB-“ rated bonds trading above a spread of 250, and determined that there are $138bn worth of bonds trading at near high yield levels, potentially indicating the market’s outlook that these could become fallen angels in the near future.

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 fund performance. It is not possible to invest in an index.

Rising Stars: A new issuer exited the Index in June, APA Corp. (APA), as Moody’s upgraded it to Baa3 from Ba1, reflecting the company’s strong financial results, improving balance sheet and stronger credit metrics. Moody’s believes that APA’s ongoing debt reduction (since 2020), will continue to improve its balance sheet and provide a more resilient financial profile. APA was downgraded in June 2020, entering the Index at a price of $83.79 and weight of 2.86%, and now exits the Index at $82.69/3.84%. During its two years in the Index, it returned -1.31% vs -6.40% (in price terms) for the broad high yield market. APA is the third Energy sector issue to be upgraded this year, reducing the sector exposure from close to 30% at the beginning of the year to 15% now. Upgrades to investment grade have accounted for 32.01% of the Index market value, making 2023 a very significant year in terms of rising stars volume. JP Morgan research conducted the same analysis for upgrades to investment grade and concluded that of the $299 billion bonds rated BB+, $24.3 could be upgraded in the near term.

Source: ICE Data Services, VanEck. 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 fund performance. It is not possible to invest in an index.

Fallen Angels Performance by Sector: Sector exposures continue changing with the exit of APA in June. The Energy sector dropped to 15.28% from 18.34% in May, which is approximately 50% of what it was a year ago. The Energy sector currently has 11 issuers, with only three of them being part of the 2020 wave of downgrades (EQM, Methanex and Rockies Express, with a total exposure of 6.75%). The other sector that saw a decrease in its exposure was Banking, to 3.20% from 5.32% in May, as an Intesa Sanpaolo issue with a weight of 2.30% was removed due to its maturity being less than 12 months. In terms of performance, only the Insurance sector posted a negative return (-0.06%) in June while the top performing sector was Financial Services (+7.91%). YTD, all sectors, except Banking, have so far posted positive performance, with Transportation, Financial Services and Leisure in the top three. Regarding spreads, all sectors except Banking saw tightening in June with the overall spread ending the month very close to the low level in February (295).

Source: ICE Data Services, VanEck. 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 fund performance. It is not possible to invest in an index.

Fallen Angels Performance by Rating: The Index continues to decrease its BB-rated exposure to the low 80s. The lower rated issuers continued outperforming their higher rated peers in June and YTD. The BB rated bucket is now above the Single-B rated bucket, which was noted last month as an indicator that BB-rated bonds may begin displaying better prices than lower rated issuers, which, outside of the small exposure to CCC-rated bonds, was the case in June.

Source: ICE Data Services, VanEck. ^*Does not have securities for all months of selected period. Returns are based on partial period data. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest in an index.