The Evolution of Retail within Fallen Angels

In April, 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”) by 0.74% (-1.74% vs -1.00%). Year to date, fallen angels are now lagging by 0.66%, with returns of -0.16% vs 0.50% for the broad high yield market as longer duration continues to impact fallen angels. Within broad high yield, single B rated bonds outperformed BB and CCC & below rated bonds in April, while CCC & below rated bonds continue to outperform higher quality YTD.

Deep Dive on Retail

Retail sector exposure within the fallen angel universe has increased to almost 20% from only about 6% in December 2022, due mainly to two large fallen angels and rising stars in other sectors. Retail is now the largest sector in the index. Below is a quick recap of what has brought us to this point:

In December 2022, Retail exposure in the Index was comprised of 10 issuers across 4 industries: Specialty Retail (approximately 0.9% weight), Department Stores (approximately 3.5%), Food & Drug Retailers (approximately 0.5%) and Restaurants (approximately 0.9%), with Nordstrom being the largest issuer at 2.0% weight.  

By November 2023, Retail sector exposure increased to just under 10%, as the index was experiencing multiple rising stars from other sectors. In December 2023, Walgreens entered the index with a 5% weight (approximately $4.4 billion par amount) following its downgrade by Moody’s, reflecting its high financial leverage and losses in its U.S. healthcare segment, bringing the sector exposure to approximately 14% of the index.

In February 2024, Advance Auto Parts entered the index with a 2% weight (approximately $2 billion of par amount), following its downgrade by Moody’s due to expected lower sales growth and higher expenses, bringing total Retail exposure to 17%.

Overall Retail exposure is currently comprised of 11 different issuers within four industries: Specialty Retail (approximately 4.3% weight), Department Stores (approximately 6.9%), Food & Drug Retailers (approximately 7.3%) and Restaurants (approximately 1.1%). Retail has been the best performing sector over the past 12 months, with a 16.51% return, and the second highest performing sector over the past six months, behind Financial Services, as it posted 15.69% contributing positively to the fallen angel index performance. Most of the performance has come from approximately 300bps of spread tightening over the last 12 months.   

Compared to other sectors, Retail has the longest duration (6.5), followed closely by Telecom, the second largest exposure. Retail has always been one of the sectors with a long duration due to the inclusion of YUM Brands (9.9), Macy’s (9.8) and Marks & Spencer (8.4). Walgreens added to the duration length, as it entered the index with an average duration of 7.8.

Fallen Angels Overall Statistics: Fallen angel yields increased by 51bps to 7.43% and spreads were relatively flat. Broad high yield saw similar changes, with yields increasing 45bps to 8.20% and spreads experiencing minimal changes. Yields jumped significantly as the 10Y increased by 49bps in April to 4.69%, a level not seen since October of last year, largely due to persistent inflationary pressures and the market’s reassessment for the potential of multiple rate cuts this year. In early May, the U.S. Federal Reserve (“Fed”) confirmed its stance that the next policy move is unlikely to be a rate hike; however, it is prepared to maintain interest rates at current levels until significant improvements are observed in economic data. Given the current environment of higher yields and lower prices, it is expected that this may bolster total returns going forward, provide a cushion against potential volatility and support the continued technical tailwind of strong investor demand.

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.

New Fallen Angels: None in April.

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.

Rising Stars: FirstEnergy Corp. and Rolls-Royce exited the index in April after being part of the 2020 wave of COVID-related downgrades. FirstEnergy Corp. entered the index in November 2020 at $111.88 (a much higher price than some if its peers, as the energy sector had recovered from its large drawdown of May 2020), while Rolls-Royce entered the index in June 2020 at $96.67; both posted negative prices returns during their time in the fallen angel index. FirstEnergy was upgraded by Moody’s to Baa3 from Ba1, reflecting a much stronger financial profile due to actions take over the past few years. Rolls-Royce saw an upgrade from all three rating agencies in March. Moody’s upgraded to Ba1 from Ba2 due to improvement in credit ratios well ahead of expectations, S&P upgraded to BBB- from BB+ on a stronger than anticipated performance, which lead to meaningful deleveraging, and Fitch upgraded to BBB- from BB+, on confidence that Rolls-Royce will sustain solid financial metrics, which are already reflective of an investment-grade profile, supported by its strong business profile.

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: Utility and Capital Goods exposures decreased with the two rising stars this past month. Utility exposure within fallen angels was significantly reduced in April with the exit of FirstEnergy (9% to approximately 2%), with the weight being redistributed among the other sectors. Retail, Energy and Real Estate gained more than 1% with Retail at an approximate 20% allocation, which is about 3.2x of the weight in the broad high yield market. Only four sectors saw spread widening, with Telecom being the major detractor. Relative to broad high yield, the top detractors from performance were Telecom and Retail, while the top contributors were the absence of Media and the selection effect within Consumer Goods sector, which was the only sector with a positive total return in the month (note that fallen angels only have one issuer, Newell Brands, within this sector while broad high yield has more than 40).

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: There were no major changes with the rating exposure for fallen angels during the month. Higher quality outperformed lower quality, as only BB-rated bonds saw their spreads tighten (almost unchanged) while lower quality widened, but all posted negative price returns.

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 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.