Yields at 8% while Rising Stars Outpace Fallen Angels

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 0.51% in September (-1.67% vs -1.16%) as the 10Y Treasury Rate increased to 4.59 from 4.09 at the end of August, causing longer duration assets to take a hit. Fallen angels have a longer duration than broad HY as they are more reflective of the longer maturities found in the investment grade (IG) space. In September, the change in rates explains more than 100% of the difference in returns, only slightly offset by the spread effects. The story, year to date, is similar as rates have generally increased, especially since March when the 10Y was hovering at 3.50 but is now close to 4.60, as illustrated in the chart below. Carry has also been a negative contributor to fallen angel underperformance, as fallen angels have a lower average yield versus the broad high yield market due to their significantly higher credit quality. However, sector exposures and selection within sectors have both been positive contributors to relative performance, somewhat offsetting the impact of higher rates. In terms of flows, high yield corporates saw another approximate 1.5bn in outflows during September following the approximate $1bn in August. Treasury and ultrashort funds continue to see inflows as the short end of the curve is where investors can find high yields with very low duration and credit risk, amid volatility in rates.

US Treasury Curve

Source: US Treasury.

Rising Stars continue to outpace Fallen Angels

This year, the fallen angel index has decreased by approximately 36% due to rising stars, compared to an increase of 14% due to new fallen angels. For context, in 2022 there were 18% of rising stars vs 8% of new fallen angels. The largest rising star this year was OXY (8.69% or approximately $9,975m in face value at the time of exit in May) while the largest fallen angel (excluding Nissan, as it entered in March and exited May) was Brandywine Operating Partnership (1.87% or approximately $1,655m in face value) this past month. Looking forward, JP Morgan estimate that rising stars will continue to exceed fallen angels in 2024, although to a lesser extent.

Source: JP Morgan.

• Ford could be the biggest rising star before the year is over. S&P is expected to review its rating in November with most sell side analysts expecting a rating upgrade (currently capped at 10% of the index).
• The high yield universe is expected to contract with more upgrades than downgrades, although the upward ratings (rising stars plus upgrades within the IG bucket) are losing some steam.
• There is approximately $10bn of BBB- debt with at least one high yield rating and negative outlook, half of which are in the technology sector. while there is approximately $72bn of BBB- without a high yield rating, but with a negative outlook.

Fallen Angels Overall Statistics: Fallen angels average yield increased by 57bps to 8.02, the highest yield since March 2020, only surpassed by the Global Financial Crisis and briefly in early 2016 when oil price declined amid concerns about China’s economic growth. Fallen angels yield is 95bps above the all-time average while broad HY saw an increase of 46bps, to 8.94, which is near what it was at the beginning of the year and 137bps above the average since December 2003. Credit spreads widened in September after a rather pronounced tightening cycle that began in March following the mini-banking crisis. Fallen angel spreads reached 314 (an increase of 21bps), while broad HY surpassed the 400 mark to 403 (an increase of 18bps), but both spreads are still more than 100bps below their long time average and in line with the short-term averages. The fallen angel market value has continued to decline this year due to rising stars. There were no defaults in September for both indices, however, S&P’s latest Default, Transition and Recovery report states that the number of global corporate defaults jumped to 107 as of August 31, 2023 with the U.S. accounting for 69 defaults. There were 16 defaults in August, the highest August monthly tally since 2009.

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: Two fallen angels were added in September, adding 2.22% to the Index market value. Brandywine Operating Partnership was downgraded by Moody’s to Ba1 from Baa3, on the expectation that coverage ratios will remain weak as commercial real estate has seen some difficulties over the past few months. This is the first fallen angel REIT so far this year, and given pressures in commercial real estate due to tighter financial conditions, rising office vacancies and stress in the regional banking sector, it will be interesting to see if more follow. The other fallen angel, Port of Newcastle Investments, is in the transportation sector. It was downgraded by S&P to BB+ from BBB- reflecting elevated levels of debt compared to S&Ps earning projections for the next few years. Despite the Port of Newcastle Investments looking for plans to improve their earnings, S&P believes that the timing of those is very unclear. Over the last six months, Brandywine Operating Partnership posted price returns of approximately +6% while Port of Newcastle Investments posted -5%.

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: One issuer exited the index in September, another energy issuer, Patterson UTI Energy, as S&P upgraded it to BBB- from BB+ and Fitch assigned a assigned a BBB- rating. Both agencies’ IG rating status is based on the financial profile of Patterson UTI Energy following the merger of NexTier Oilfields Solutions, as it creates a leading company in the oil field services with a strong presence in the U.S. Patterson UTI Energy was an energy fallen angel in March 2021, posting -6.00% price return and 5.76% total return over its time in the fallen angel index. Over the last 12 months, it posted a price return of 9.61% vs 3.29% for the broad high yield market. Despite a Patterson ITU Energy upgrade this past month, all eyes are on Ford for the rest of the year as it was upgraded by Fitch in early September to BBB-, as in their view, supply change issues over the past few years are resolved. The ongoing United Auto Workers (UAW) strike has created uncertainty over the short term, but Fitch expects that the Union will reach an agreement soon. More importantly, S&P is expected to review its Ford rating in November of this year, with most sell side analysts expecting a rating upgrade and thus, it’s removal from the fallen angel index, reducing the Auto sector’s exposure to 0%.

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.

Fallen Angels Performance by Sector: Only the services sector posted a positive return for September (+0.81%), but with a small exposure (0.56%), it was not enough to offset the negative performance of the others 16 sectors that compose the fallen angel index. Year to date, the banking sector is the only sector (aside from a -0.01% return of the insurance sector) that posted negative returns, reflective of the stress experienced in that sector this year. Changes in sector exposures has been a theme this year, in particular the decrease in Energy exposure, driven by rising star activity. In September, the real estate sector saw an increase with a new fallen angel, while energy continued its downward trend to below 15%. As of month-end, 9% is trade in the $70s, 66% of fallen angels (up from 63% last month) are now trading in the $80s, 25% (down from 37%) in the $90s and no sector continues to be above par.

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: Single-B rated issuers outperform BB and CCC & lower rated issuers in September. As we wrote last month, CCC & lower rated issuers have outperformed YTD due to robust U.S. growth data and better-than-expected earnings. Diversified Healthcare Trust (DHT), a REIT, is the CC rated issuer (upon Moody’s downgrade to Ca in early September) following the notice that the merger between DHT and Office Properties Income Trust was cancelled.

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.