Looking Ahead to Potential Fallen Angel Drivers

Fallen Angel Bond Recap and Outlook

August 2023

Hi, I'm Nicolas Fonseca and welcome to the U.S. fallen angel update for August.

Let's talk performance first.

Fallen angels underperformed the broad high yield market by 25 basis points in August, with fallen angels returning 4 bps vs 29 bps for the broad high yield market.

Underperformance in August continues to be driven by lower quality bonds as these issuers continue to outperform due to robust U.S. growth data and better than expected earnings.

At the same time August was volatile in terms of yields. The 10-year, for example, increased from 3.97 to 4.34 and ended the month at 4.09. Meanwhile fallen angels started at 7.25, jumped to 7.69 which is the highest it's been all year and ended the month at 7.45.

Also covering price returns. Price returns for fallen angels are a key differentiator when we look at performance versus broad high yield. And this happens because it's driven by systematic purchase of oversold or undervalued bonds that have been downgraded to high yield, which tend to recover those losses in the following months after the downgrade happens.

Unfortunately, in 2023 price returns has been a detractor, and there are two main reasons for it. First one, there hasn't been a ton of fallen angels. And the second one is, the ones that had been fallen angels, their duration has been extremely long. Even though there's been a ton of rising stars, which have usually boosted performance, it hasn't been the key this year due to their extended duration.

Going forward, we're looking into different paths where price performance could be a driver of outperformance once again.

An economic slowdown should widen spreads in the coming months, where lower quality issuers may be more vulnerable as they have limited capacity to refinance and sustain higher interest costs. With wider spreads, higher quality bonds may outperform.

In a more risk-off environment, there could be a decline in yields from their elevated levels which would benefit long duration bonds. And more importantly, a credit-weakness environment may bring higher volume of fallen angels, similar to what happened in 2020. So far, we've seen some lower profits, higher funding costs, and

defaults increase among leveraged borrowers.

Overall, we do envision scenarios where downgrades increase. And historically, fallen angel price returns have been their strongest following a wave of downgrades, like it happened in 2020.

Thank you for watching and don't forget to visit VanEck.com for more insights.