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Fallen Angels: New Downgrades End Seven Month Drought

16 October 2024

Read Time 8 MIN

The seven-month drought of fallen angels ended in September with two downgrades to high yield, while possible downgrades of Boeing and Paramount have the potential to have a significant impact.

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 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)

Fallen Angel US High Yield vs. Broad US High Yield (as of 9/30/2024)

Source: ICE Data services and VanEck.

  Fallen Angels Broad HY
  12/31/23 3/31/24 6/30/24 9/30/24 12/31/23 3/31/24 6/30/24 9/30/24
Yield to Worst 6.99 6.92 7.10 6.43 7.69 7.75 7.94 6.98
Par Weighted Price 91.20 91.22 90.32 93.69 91.86 93.18 92.98 96.72
Effective Duration 5.41 5.32 5.08 5.04 3.31 3.28 3.26 3.04
Full Market Value ($mn) 67,821 64,657 55,371 57,236 1,237,721 1,260,542 1,266,993 1,336,160
OAS 285 247 252 261 339 315 321 330
No. of Issues 143 138 126 124 1,837 1,864 1,863 1,873

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.

Month-end Addition Name Rating Sector Industry % Mkt Value Price
January Hudson Pacific Properties LP BB1 Real Estate REITs 2.18 88.05
February Advance Auto Parts Inc. BB1 Retail Specialty Retail 2.52 91.20
September OCI NV BB1 Basic Industry Chemicals 1.10 104.79
September V.F. Corp BB1 Retail Specialty Retail 3.04 94.08

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: 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.

Month-end Exit Name Rating Sector Industry % Mkt Value Price
February Las Vegas Sands Corp BB1 Leisure Gaming 3.12 93.19
March Enlink Midstream Partners LP BB1 Energy Gas Distribution 2.30 88.92
April FirstEnergy Corp. BB1 Utility Electric-Integrated 6.62 87.10
April Rolls-Royce PLC BB1 Capital Goods Aerospace/Defense 1.51 96.00
July Delta Air Lines Inc. BB1 Transportation Air Transportation 1.50 94.59
September Port of Newcastle Investments Financing Pty Limited BB1 Transportation Transport Infrastructure/Services 0.52 95.59

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.

  Wgt (%) OAS Price Total Return
  12/31/23 3/31/24 6/30/24 9/30/24 12/31/23 3/31/24 6/30/24 9/30/24 12/31/23 3/31/24 6/30/24 9/30/24 MTD YTD
Banking 4.79 4.62 5.38 5.45 231 235 220 210 97.91 97.11 97.36 101.29 2.18 7.70
Basic Industry 1.70 3.20 3.73 4.78 171 186 156 190 97.24 94.37 95.03 99.25 0.89 6.71
Capital Goods 5.85 6.17 5.41 5.31 200 153 161 198 97.34 97.38 97.51 98.72 0.74 5.60
Consumer Goods 4.33 4.42 5.28 5.22 230 223 240 231 94.29 93.07 93.64 97.25 1.56 7.95
Energy 14.75 11.17 12.27 12.13 259 235 239 267 92.49 93.95 93.44 95.40 0.20 7.19
Financial Services 1.14 1.18 1.37 1.40 378 336 376 324 86.41 87.09 84.87 91.57 2.45 10.84
Healthcare 4.10 4.44 5.15 5.29 270 210 207 157 88.73 90.80 91.12 95.88 1.45 12.45
Insurance 1.32 1.43 1.65 1.67 323 244 238 237 94.10 96.82 96.11 100.34 1.46 11.67
Leisure 7.90 5.10 5.92 4.90 228 170 180 234 93.21 95.08 94.48 95.41 0.93 6.23
Real Estate 9.07 9.60 10.07 10.23 675 527 450 389 82.72 81.84 84.76 89.79 2.17 5.72
Retail 14.38 18.02 20.45 21.67 242 179 196 252 86.39 89.54 88.19 88.38 0.73 3.94
Services 0.64 0.66 0.79 0.78 243 217 206 202 94.78 94.51 94.67 98.11 0.64 7.55
Technology & Electronics 6.22 5.81 6.67 6.66 194 188 184 206 94.14 92.99 92.27 94.38 0.58 4.94
Telecommunications 13.00 13.39 11.10 11.82 366 368 413 351 92.22 90.01 81.48 92.33 2.46 7.78
Transportation 2.09 2.23 2.60 0.57 209 170 150 210 94.92 95.37 96.07 106.22 3.14 7.43
Utility 8.71 8.54 2.17 2.11 139 122 185 203 92.18 91.13 96.23 99.44 1.64 4.26
Total 100 100 100 100 285 247 252 261 91.20 91.22 90.32 93.69 1.28 6.19

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.

  Wgt (%) OAS Price Total Return
  12/31/23 3/31/24 6/30/24 9/30/24 12/31/23 3/31/24 6/30/24 9/30/24 12/31/23 3/31/24 6/30/24 9/30/24 MTD YTD
BB 80.55 81.63 87.62 87.30 219 190 210 223 92.44 92.85 92.62 95.29 6.62 5.11
B 13.43 12.87 7.89 7.32 317 330 371 382 96.46 93.99 90.73 92.36 2.92 4.38
CCC 5.44 5.51 4.19 4.38 1,130 893 505 468 69.40 68.48 80.90 87.61 4.16 4.80
CC*     0.30 1.00     5,719 1,703     13.00 44.51 253.61 4.91
Total 100 100 100 100.00 285 247 252 261 91.20 91.22 90.32 93.69 6.19 5.04

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.