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Fallen Angels Index Outperformed Broad High Yield Index… Again: 14 Out of 18 Years

The fallen angels index outperformed the broad high yield index by 0.40% in December and by 2.36% for 2021 (7.72% vs 5.36%), making it the 14th year that fallen angels have outperformed broad high yield over the last 18 calendar years. The majority of the outperformance in 2021 came from the energy sector, where fallen angels are overweight the broad high yield index by more than 2x. Within energy, Occidental Petroleum was the biggest contributor to outperformance from an issuer perspective, accounting for 1.68% of the YTD figure. The VanEck Fallen Angels Bond ETF (ANGL) provides investors access to this historic outperformance.

Fallen Angels and Broad High Yield Returns for 2021

Fallen Angels and Broad High Yield Returns for 2021

Fallen Angels and Broad High Yield Returns for 2021

Source: VanEck, ICE Data Services. As of 12/31/2021. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. For fund performance current to the most recent month-end, visit vaneck.com. Fallen Angels Index (ICE US Fallen Angel High Yield 10% Constrained Index); Broad high yield index (ICE BofAML US High Yield Index).

2021 in Review

Compared to the roller coaster of 2020, 2021 was much more of a smooth drive. In 2020 we saw the fallen angel index’s market value increase from $110bn to $253bn due to the large number of downgrades that occurred earlier in 2020. In 2021, there were some fallen angels – a much lower amount than 2020 – idiosyncratic in nature. The story was and will continue to be rising stars, we believe.

  • The 10Y U.S. Treasury yield had distinct periods of both rising and decreasing levels, but overall increased last year. It began the year at 0.93%, rose to 1.74% by the end of March, stayed within a 1.40-1.70% band for a couple of months, dipped to 1.19% at the beginning of August, rose back up to 1.68% late October and finished the year yielding 1.52%.
  • Investors may have expected longer duration to get hit, but that was wasn’t the case for fallen angels in 2021, despite finishing the year with a 1.8x longer duration than broad HY. Interest rate movements, historically, have not been a primary driver of long-term outperformance relative to the broader market and that was true again last year. In fact, fallen angels came out on top of the broad HY despite the 10Y rising 0.59%.
  • Overall, credit selection and spread effects (i.e. a greater benefit from spread tightening) primarily explained outperformance on 2021.
  • Number of fallen angel issuers: 11, adding 5.03% to the index.
  • Number of rising stars issuers: 12, removing 12.13% of the index. These 12 issuers added 0.67% out of 2.36% of outperformance vs the broad HY for the calendar year.
  • Top 2021 Sectors: Energy and Consumer Goods contributed the most of the outperformance over broad HY (+3.46%), while no Media allocation in fallen angels and underweight position in Healthcare were top detractor (-0.86%).
  • Top 2021 Issuers: The 2020 fallen angels, but most importantly, the future rising stars haven been driving performance. Oxy, Kraft, Ford, Western Midstream and APA were the top 5 issuers that contributed to relative outperformance vs broad high yield.

Fallen Angels, Broad High Yield and 10 Year Treasury Levels 2021

Fallen Angels, Broad High Yield and 10 Year Treasury Levels 2021

Fallen Angels, Broad High Yield and 10 Year Treasury Levels 2021

Source: VanEck, ICE Data Services. As of 12/31/2021. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. For fund performance current to the most recent month-end, visit vaneck.com. Fallen Angels Index (ICE US Fallen Angel High Yield 10% Constrained Index); Broad high yield index (ICE BofAML US High Yield Index).

2022 Story: Rising Stars or the Fed?

Will rising stars or the Fed drive returns? Probably both.

Rising stars are bonds that are upgraded from high yield into investment grade. Over the 12 months prior to the upgrades, these bonds tend to outperform broad high yield by an average of 8.19% (since December 2003), as the market is often able to identify companies that exhibit improving fundamentals and are able to meet financial obligations with lower levels of credit risk. The 2021 rising stars outperformed broad HY by 9.61%, so we expect to see that continue over the course of the year. With forecasts for up to $100-200+ billion of high yield rising stars next year, 2022 has the potential to significantly exceed this year’s already elevated ascension rate.

Fallen Angels Average Price Return Prior to Credit Rating Upgrades

Fallen Angels Average Price Return Prior to Credit Rating Upgrades

Fallen Angels Average Price Return Prior to Credit Rating Upgrades

Source: VanEck, ICE Data Services. As of 12/31/2021. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. For fund performance current to the most recent month-end, visit vaneck.com. Fallen Angels Index (ICE US Fallen Angel High Yield 10% Constrained Index); Broad high yield index (ICE BofAML US High Yield Index).

Note: Cenovus, Nordstrom and EPR Properties don’t have 12 months in HY but the chart above includes 12 months before last upgrade to IG.

Bond investors, however, cannot help but worry about possible Fed actions in 2022, after they mentioned the start of tapering back in November. Initially, the reduction was $10 billion less in Treasury and $5 billion less in mortgage-backed securities, however, it has picked up its pace: $20 billion in Treasury and $10 billion for mortgage-backed securities with the goal to have no net new purchases by mid-2022. There has been no taper tantrum this time as the 10Y barely moved (see above).

Not only that, but rate hikes might also be coming sooner than later in the new year. Historically, however, Fed hikes and rising bond yields have not necessarily meant underperformance of fallen angels, despite their longer duration. We looked back to 2004 to see what fallen angels have performed during rising rate periods. We only found 2 periods since 2003 where Fed Funds were raised and in both times fallen angels outperformed the broad high yield market.

  • Middle of 2004 to middle of 2006: Fed Funds were raised from ~1% to ~5.25% and the fallen angels outperformed by 1.59% (18.65% vs 17.06%).
  • From October 2015 to January 2019: Fed Funds were raised from ~0% to ~2.5% and the fallen angels outperformed by 8.93% (31.87% vs 22.94%).

Fed Fund Hikes vs Fallen Angels + Broad HY Returns

Fed Fund Hikes vs Fallen Angels + Broad HY Returns

Fed Fund Hikes vs Fallen Angels + Broad HY Returns

Source: VanEck, ICE Data Services, US Treasury. As of 12/31/2021. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. For fund performance current to the most recent month-end, visit vaneck.com. Fallen Angels Index (ICE US Fallen Angel High Yield 10% Constrained Index); Broad high yield index (ICE BofAML US High Yield Index).

Similarly, the fallen angels Index has outperformed the broad high yield market in 2 calendar years in which bonds yields have risen significantly (as measured by an increase in the 5-year Treasury yield of more than 100 basis points: 2009 and 2013). Outperformance during these years has averaged 4.60%. More details can be found here.

Fallen Angels Index Overall Stats:

The average yield to worst of fallen angels Index decreased by 0.38% during 2021 while it increased 0.12% on the broad high yield index. The main cause for this was the high issuance of high yield bonds (with longer duration), none of which make up the fallen angel universe. Among fallen angels, although interest rates rose 0.59% (the 10Y), spreads tightened by 102 bps, a negative relationship that is typical in strong credit environments. From a duration standpoint, the average duration among fallen angels increased by merely 0.09 while broad HY increased by 0.44, primarily reflecting new issuance. The market value of the fallen angels index has declined from $252bn at the beginning of 2020 to $196bn as a result of mostly rising stars since the beginning of the year; however, keep in mind that before COVID (December 2019) the market value was $110bn.

Fallen Angel Stats

12/31/20206/30/202112/31/202112/31/20206/30/202112/31/2021
Yield to Worst3.803.353.424.243.864.32
Mod. Dur to Worst6.826.816.913.373.633.81
Full Market Value ($mn)252,730233,701196,9321,543,2691,640,7681,610,169
No. of Issues3282952622,0302,1102,123

Source: VanEck, ICE Data Services. As of 12/31/2021. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. For fund performance current to the most recent month-end, visit vaneck.com. Fallen Angels Index (ICE US Fallen Angel High Yield 10% Constrained Index); Broad high yield index (ICE BofAML US High Yield Index).

2021 Fallen Angels:

Fallen angels comprised a lower percentage of market value vs 2021 with only 5.03% of new fallen angels in 2021. We still saw some and the expectations is to still see a small number of fallen angels bonds in the coming months as the credit environment is still in good conditions.

Fallen Angel Sectors and Market Value

SeptemberNordstrom Inc.BB1RetailDepartment Stores1.35102.07
SeptemberPerrigo Finance Unlimited CompanyBB1HealthcarePharmaceuticals1.22104.99
SeptemberGenting New York Llc / Genny Cap IncBB1LeisureGaming0.2599.21
SeptemberDomtar CorporationBB2Basic IndustryForestry/Paper0.25103.36
AugustBrightsphere Investment Group IncBB1Financial ServicesInvestments & Misc Financial Services0.14108.76
AugustResorts World Las Vegas Llc / Rwlv Cap IncBB1LeisureHotels0.67102.96
JuneVerizon Florida IncB1TelecommunicationsTelecom – Wireline Integrated & Services0.15108.14
MayProassurance CorpBB1InsuranceP&C0.12107.72
MarchPatteron Uti EnergyBB1EnergyOil Field Equipment & Services0.3796.01
FebruaryTechnipFMCBB1EnergyOil Field Equipment & Services0.20104.20
FebruaryHexcel CorporationBB1Capital GoodsAerospace/Defense0.31106.15

Source: VanEck, ICE Data Services. As of 12/31/2021.

2021 Rising Stars:

As expected, rising stars are becoming a bigger part of the fallen angel story. In December, there was just 1 new rising star. This addition puts the count at 12 issuers which in terms of ascension to investment grade, since index inception, is on the upper end. The average price return for these 12 issues, over the last 12 months before the upgrade to investment grade was of 15.23% vs 5.62% for the broad HY.

Rising Stars Sectors and Market Value

DecemberGoldman Sachs Capital IBB1Financial ServicesBrokerage0.68138.02
NovemberContinental Resources Inc.BB1EnergyEnergy – Exploration & Production0.86107.30
NovemberDell IncBB1Technology & ElectronicsTech Hardware & Equipment0.58122.73
NovemberFirstenergy Transmission LlcBB1UtilityElectric-Distr/Trans0.29116.91
NovemberOvintiv IncBB1EnergyEnergy – Exploration & Production1.83128.12
OctoberCF Industries Inc.BB1Basic IndustryChemicals1.56120.09
SeptemberEPR PropertiesBB1Real EstateREITs1.23107.10
AugustArcelorMittal S.A.BB1Basic IndustrySteel Producers/Products1.36126.68
AprilMDC HoldingsBB1Basic IndustryBuilding & Constructions0.41122.88
MarchNordstrom Inc.BB1RetailDepartment Stores0.92102.12
MarchSmurfit Capital Funding PLCBB1Capital GoodsPackaging0.16122.87
JanuaryCenovus EnergyBB1EnergyIntegrated Energy2.25115.88

Source: VanEck, ICE Data Services. As of 12/31/2021.

Fallen Angels Performance by Sector:

16 out of the 17 sectors posted positive returns for 2021 with only Telecom being on red figures. Top performing sector was Energy, posting +14.42% for 2021. Fallen angels have maintained its higher allocation to Energy at ~28%, followed by Consumer Goods and Autos which have also positively contributed. Energy still has a lower price than the index, meaning that there is still more room to run, and oil appears to rise as OPEC+ agreed to increase the oil output starting February.

Fallen Angels Performance and Allocation by Sector

12/3120206/30/202112/31/202112/31/20206/30/202112/31/202112/31/20206/30/202112/31/202112/31/2021
Automotive10.0010.0010.00274186147106.31108.83109.857.19
Banking3.643.974.07215147125116.71118.33114.905.82
Basic Industry6.946.544.25236179173114.88115.34112.445.80
Capital Goods3.083.474.12305260225110.43110.27110.725.86
Consumer Goods12.3811.7512.95221147142114.82118.83120.438.14
Energy28.8328.9328.0439326724099.25104.78106.4214.42
Financial Services0.921.011.03263196240124.95125.50101.373.66
Healthcare0.480.531.98369199180109.42114.97106.518.81
Insurance0.420.610.4667339528394.84101.95104.2814.25
Leisure4.854.973.76372273269112.40112.20105.755.27
Real Estate3.773.732.7251131841396.45101.4197.124.55
Retail3.552.634.7842727627098.33103.98101.969.31
Services1.010.920.3923215087103.42103.50103.863.80
Technology & Electronics4.244.323.44224175176110.26110.31109.253.97
Telecommunications7.488.029.11272258283131.86126.33121.24(2.18)
Transportation1.961.711.66336304221100.97102.45104.186.58
Utility6.456.877.24207180158111.11110.06109.462.62
Total100100100313225211107.67110.57110.077.72

Source: VanEck, ICE Data Services. As of 12/31/2021. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. For fund performance current to the most recent month-end, visit vaneck.com.

Fallen Angels Performance by Rating:

Fallen angels have kept its high exposure to BB-rated bonds since mid-2020 and it appears that it will stay like this for some time. Down in quality played an important role this past year as triple CCC and below outperformed its high rated peers, however, that outperformance has come at a cost as volatility of that bucket has been much more elevated that BB and B-rated bonds. The combination of potential downside protection in volatile spread widening environments, and a higher exposure to potential rising stars, may make the higher quality nature of fallen angels attractive going forward in 2022.

Fallen Angels Ratings and Performance

12/31/20206/30/202112/31/202112/31/20206/30/202112/31/202112/31/20206/30/202112/31/202112/31/2021
BB94.5693.9194.49296214200108.81111.25110.707.27
B3.964.374.0847032031999.34105.02105.7510.86
CCC1.141.411.1363947942591.6699.70102.9921.91
CC0.150.320.312,2541,0431,34633.9968.1355.9983.05
C0.192,32160.034.06
Total100100100313225211107.67110.57110.077.72

Source: VanEck, ICE Data Services. As of 12/31/2021. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. For fund performance current to the most recent month-end, visit vaneck.com.

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Originally published by VanEck on January 26, 2022.

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