Rising Stars Have Liftoff

Fallen angels (as represented by the ICE US Fallen Angel High Yield 10% Constrained Index, “H0CF”) underperformed broad HY (as represented by the ICE BofA US High Yield Index, “H0A0”) by 0.21% (-1.16% vs -0.95%) in May and are now lagging by 0.70% YTD (3.03% vs 3.73%). The year’s trend of lower quality outperforming higher rated peers continued in May, despite all high yield rating buckets posting negative returns as yield rose and spreads widened, mostly due to the uncertainty about the U.S. debt ceiling which was resolved in the first few days of June.

Fixed income U.S. listed ETFs saw approximately $14bn in inflows during May, with the majority of inflows into Multi-Sector and Treasury products and outflows from High Yield (~$2bn) and Loans. The intermediate duration bucket continues to gather flows with money flowing into the long part of the curve.

The main fallen angel story in May was the upgrades to investment grade, and accompanying exit, of three issuers from the Index (“rising stars”). The fallen angel Index saw more than $20bn of par value (approximately 17.4% of the market value) exit the Index as Occidental Petroleum (OXY), Nissan and Mattel were upgraded to investment grade over the course of the month.

• Fitch upgraded OXY to investment grade earlier in the month, stating that the main driver was the improvement in midcycle credit metrics, stemming from the combination of incremental de-leveraging, along with anticipated improvements in midcycle earnings in the chemicals and midstream segments. The upgrade was widely expected, as in March, Moody’s upgraded OXY alongside Western Midstream on the heels of improved credit metrics. Both upgrades showed the continued efforts from the companies to return to investment grade status after their respective downgrades in April 2020. OXY entered the Index at a par weighted price of $71.76 and exited at $93.82, providing a double-digit price return over the 37 months in the Index. OXY was also the top contributor to outperformance over the broad high yield index over the same time period, approximately double the next closest issuer.
• A recent fallen angel – Nissan – exited the Index at the end of May. Fitch gave it a BBB- rating in late April after it had withdrawn it back in 2018, resulting in an average investment grade rating. Nissan entered the Index at 8% in March 2023, increasing Auto exposure into the high teens. The removal of Nissan brings the sector back down to 10%, with Ford as the only issuer in the Auto space. Ford, like OXY, is included in many sell side forecasts as a potential rising star. Nissan’s return is not as impressive as OXY, as it was only part of the Index for two months. It entered with a $91.05 price and exited at $87.37.
• The third issuer that exited the Index in May was Mattel. S&P’s upgrade to investment grade was due to Mattel reporting strong underlying fundamentals in the first quarter. Mattel reported market share gains in all three core product categories, outpacing the toy industry. S&P stated that it is confident that Mattel's recovery over the past few years is largely sustainable. Mattel had been in the Consumer Goods sector since November 2017 when it entered at a 1.3% weight and despite posting a negative price return (entered at $97.46; exited at $85.32), it provided higher than average spreads and yields than the Consumer Goods sector as a whole, which meant a 22% cumulative total return (8% higher than the sector).

Fallen Angels Overall Statistics: Fallen angels yields increased, alongside all fixed income instruments, in May by 41bps while broad HY yields increased by 42bps. The fallen angels yield of 7.55 is the highest it’s been since November 2022 and it’s approximately 200bps above the 3, 5 and 10-year average, continuing to offer a strong cushion to returns going forward, even in a spread widening environment. Spreads widened by 13bps in May for fallen angels and continue to be just shy of the 5 and 10-year average (by only 14bps and 27bps, respectively) while already above the 3-year average by 17bps. The era of low yields appears to be long gone, which may continue to benefit fixed income investors for the foreseeable future.

Duration shortened by 24bps as the issuers upgraded had, on average, much longer duration (OXY 7.84, Nissan 3.75 and Mattel 10.43) than the Index. The market value of the Index decreased due to these upgrades, dipping below $100bn for the first time. The previous times the Index was close to $100bn, which has occurred twice (November 2008 and September 2019), it increased over the following months as a there were significant downgrades. The forward cumulative total returns for the fallen angel index after those two instances were 85% (1Y), 123% (2Y) and 128% (3Y) after November 2008 and 8% (1Y), 26% (2Y) and 5% (3Y) after September 2019 and it outperformed broad high yield by an average of 27% (November 2008) and 8% (September 2019).

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: No new fallen angels 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 fund performance. It is not possible to invest in an index.

Rising Stars: As mentioned above, multiple rising stars in May removed 17.33% of the Index. OXY and Nissan joined Sprint, Western Midstream and Kraft as the biggest rising stars over the last 2 years. At a 10% weight, Ford remains the largest issuer in the Index and is also expected by many sell side research desks to be upgraded at some point in the future.

Source: ICE Data Services, VanEck. 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: Sector exposures continues to change following the shakeups of the last couple of months. With the exit of OXY, Energy sector weight dropped from 23.44% to 18.34%. Energy continues to be the highest exposure in the Index but has been cut almost 50% from its peak. Nissan, a short-lived fallen angel, reduced Auto exposure from 18.24% to 10.00%, resulting in Leisure becoming the second largest exposure with a weight of 10.13%, with Las Vegas Sands at 45% of the sector. In terms of performance, only three sectors posted positive returns in May (Retail, Tech and Transportation) and the Banking sector continues to be the only one with negative YTD returns. First Republic Bank was removed from the Index as rating agencies withdrew their credit rating after the announcement of the Bank’s closure by the California Department of Financial Protection and Innovation and appointment of the Federal Deposit Insurance Corporation (FDIC) as receiver. In terms of sector attribution vs broad high yield, underweights Healthcare and Telecom contributed the most while Energy and Banking were top detractors for May. In terms of bond prices, the average Index price dipped down into the mid $80s as the $70s bucket saw an increase from 0% on April 30 to 13.49% on May 31, which is the highest it’s been this year.

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: The Index’s BB exposure decreased to the low 80s, and had a lower average price than single B rated bonds. This has only been observed 11 other times historically, and, has never lasted for more than four months (March 2013 thru June 2013). The still high exposure to BB bonds may begin displaying better price returns than lower rated peers. When this scenario last occurred, the 6-month average forward price return had been 3.1% for BBs vs -9.1% for Single-B, and the 12-month average forward price return was 10.9% vs 3.6%.

Source: ICE Data Services, VanEck. 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.