Watch These Fallen Angel Sectors: Real Estate and Banking

In May, 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 0.13% (1.01% vs 1.14%). Fallen angels now lag by 0.79% YTD, with returns of 0.85% vs 1.64% for the broad high yield market. Within broad high yield, BB and CCC and below rated bonds posted the same return, 1.23%, while single B rated bonds underperformed by 0.27%, posting 0.96% in May. Lower quality high yield continues to be ahead so far this year due to much higher yields (average yields of 13.5%, to date), as well as a shorter duration, which translated into a -0.87% price return and 3.68% income return for the CCC and lower rated bonds. Fallen angel spreads are still tight, currently at 260bps, which is 2bps below the YTD average, 31bps below the 3Y average and 102bps below the 10Y average, but 60bps above the lowest all time spread, which occurred in October 2021, at 200bps.

Source: ICE Data Services, VanEck. Past performance is no guarantee of future results.

Where are Fallen Angels sectors relative to Broad HY now?

Fallen angels deliver a distinct value proposition that sets them apart from the overall high yield market. Fallen angels generally have differentiated sector exposure, which has been one of the drivers of long-term outperformance as these issuers tend to have sector biases as a result of broad economic factors (for example, going overweight Autos in 2004/2005 and Energy in 2016, the COVID pandemic and what is now playing out in the Real Estate sector). Historically this has allowed investors to participate in an entire sector’s recovery, as bonds may be oversold prior to downgrade and subsequently recover in price.

The table below details the current positioning of fallen angels vs broad high yield.

• Fallen angels have a more distinct sector exposure than broad high yield, which has helped drive prior differentiated returns. Banking and Real Estate are indicative, as fallen angels are overweight 6.7x and 3.3x, respectively, and both offer wider spreads (3bps and 249bps wider) and higher yields (33bps and 245bps). The lack of Auto and Media exposure in fallen angels differs from broad high yield, as the latter has approximately 11% combined exposure to both sectors.
• All fallen angels sectors have a longer duration than high yield which investors can take advantage of when rate cuts occur to avoid or limit reinvestment risk while still maintaining caution on excessive duration risk.

^*No fallen angel exposure. As of 5/31/24.

Source: ICE Data Services, VanEck.

Fallen Angels Overall Statistics: Fallen angel yields decreased by 13bps to 7.30% while spreads continue to trade rangebound in the mid-200s. Broad high yield saw similar changes, with yields decreasing 16bps but still above 8.00% and spreads experiencing minimal changes, as the 10Y rallied with yields falling approximately 20bps due to slightly better inflation data and strong earnings. With no fallen angel or rising star activity this past month, the change in duration was muted.

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: There were no fallen angels in May but we continue to keep an eye on real estate exposure, as early June saw Moody’s put six regional banks on review for downgrades due to their substantial exposure to commercial real estate loans, particularly in office space. Boeing continues to be on our radar as all three rating agencies rated it BBB-/Baa3 with a negative watch/outlook.

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: None in May.

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: All sectors, except for Real Estate, posted positive returns in May, with Transportation and Insurance being the top performers, although their contribution to return was limited due to their small exposures. Real Estate and Telecom were bottom performers, as both were the only sectors to see their price decline in May. These sectors have the lowest average price, highest spreads and among the highest weightings (approximately 22%) within fallen angels. Relative to broad high yield, fallen angels’ Retail and Banking sectors were top contributors to performance due to their overweights, while Real Estate was the main detractor to performance due to its high weighting and wider spreads, with most issuers in the index exposed to commercial real estate.

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 major changes within the rating exposure for fallen angels this past month, with BBs still at an 80% exposure. Higher quality within fallen angels outperformed lower quality, as lower quality spreads widened and their prices declined.

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.