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Revisiting Performance Through Tight Spreads

Spreads remain tight, but fallen angels have historically outperformed in similar environments; sector exposures continue to evolve, following one new fallen angel and one rising star last month.

In February, 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 0.70% (-0.40% vs 0.30%). Year-to-date, fallen angels are behind by 0.14%, posting returns of 0.17% versus 0.32% for the broad high yield market.

During the same period, lower-quality assets outperformed their higher-rated counterparts, and short-duration investments outpaced long-duration ones. This trend coincided with a 0.26% increase in the 10-year yield, reaching 4.25% by the end of February. The strong rally in risk-assets that began in the fourth quarter continued through February, which has resulted in tight spreads in all credit asset classes. High yield bond spreads are not far from their post-COVID spreads while high overall yields have continued to attract investors, despite these tight spread levels.

Revisiting Performance Through Tight Spreads

In our 2021 outlook for fallen angels, we extensively covered their performance in tight spread environments, marked by a downtrend from the elevated levels observed in March 2020, when both fallen angels and broad high yield stood at around 1000bps, to the mid to low 300s. By October 2021, fallen angels spreads reached their all-time lows at 200bps, while broad high yield saw spreads hit 301 bps, approximately 60bps wider than their previous all-time lows in June 2007 at 241bps.

Currently, we find ourselves in a situation with similar spread levels, where fallen angels have spreads at 260bps and broad high yield stands at 329bps. It is noteworthy that this similarity in spread levels exists in vastly different economic environments. Historically, fallen angels have outperformed in periods of below average spread levels.

This has been driven by the fallen angel technical effect (price recovery or appreciation after bonds are downgraded to high yield), contrarian sector exposures and a higher average credit. These factors have collectively contributed to the resilience and potential for outperformance by fallen angels in periods where spreads remain below their long-term average for prolonged periods. With overweights to Retail and Real Estate sectors (which have increased, particularly exposure to commercial REITs) and an 82% allocation to BB rated bonds, compared to 50% for broad high yield, fallen angels may be positioned favorably.

Fallen Angels Outperformance Over Tight Spread Periods

 bar chart comparing Fallen Angels Outperformance Over Tight Spread Periods

Beg DateEnd Date# YearsFallen AngelBroad HYOver/underperformance
12/31/200311/14/20073.8730.6530.550.11
1/11/20116/2/20110.396.864.901.96
1/2/201312/9/20141.9316.849.247.60
2/3/20157/21/20150.461.251.000.25
9/29/20163/5/20203.4327.8521.925.93
10/6/20166/15/20225.69-1.20-2.391.20
7/19/20222/29/20241.6214.3914.360.03
Average ->2.492.44

Source: ICE Data Services, VanEck. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Broad HY: ICE BofA US High Yield Index. Index performance is not representative of fund performance. It is not possible to invest in an index. Past performance is no guarantee of future results.

Fallen Angels Overall Statistics: The yields on fallen angels recently surpassed 7%, while spreads experienced a tightening of 23bps over the past month, settling at 260bps. Although this level has not been observed since April 2022, it remains notably higher (60bps) than the lows recorded in October 2021 at 200bps. This trend persists due to ongoing resilient economic growth, better-than-expected earnings and elevated yields, with the 10-year yield rising to 4.25% from 3.99%. Given the sustained elevation in yields, we believe investors still have the opportunity to capitalize on higher yields, providing a potential cushion if spreads were to widen significantly. In terms of defaults, fallen angels have yet to experience any so far this year, in contrast to the broad high yield market, which saw another issuer, Cano Health (holding $300 million par outstanding), default. This brings the total defaults for the broader high-yield market to two for the year, thus far. The discrepancy in default rates emphasizes the relative resilience of fallen angels and higher quality amid the evolving economic landscape.

12/31/20231/31/20242/29/202412/31/20231/31/20242/29/2024
Yield to Worst6.996.967.097.697.847.90
Effective Duration5.415.435.433.313.333.34
Full Market Value ($mn)67,82167,72666,3271,237,7211,245,5141,251,788
OAS285283260339359329
No. of Issues1431431441,8371,8471,862

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: In February, Advance Auto Parts (AAP) entered the index and added 2.52% to the Retail sector which now represents the largest exposure of the fallen angel index at 17.20%. AAP was downgraded by Moody’s to Baa3 from Baa2 as it expects AAP’s EBITDA margins to remain below historical levels, reflecting lower sales growth and gross margins with much higher expenses. Moody’s still rates the company as investment grade, but S&P had downgraded it to BB+ from BBB- in September 2023 due to weak credit metrics, as its sales were relatively flat while its competitors grew. Following the Moody’s downgrade, the average rating is high yield. The average price of AAP’s bonds six months ago was $89.17, and it entered the index at an average price of $91.20.

JanuaryHudson Pacific Properties LPBB1Real EstateREITs2.1888.05
FebruaryAdvance Auto Parts Inc.BB1RetailSpecialty Retail2.5291.20

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: The first rising star of the year is Las Vegas Sands (LVS), exiting the index at $93.19 (weight 3.12%) while joining the index back in June 2022 at $89.72 (3.32%), providing a 3.87% price return over the 20 months in the index. During the same 20 months, the fallen angel index price return was 2.10%. On February 1, LVS was upgraded by Fitch to BBB- from BB+, reflecting the strong rebound in Macao and outperformance in Singapore. LVS highlighted the growth in Macao during most of 2023 as all COVID-19 measures were dropped in the region, allowing for gamblers to come and go as they pleased with no capacity limits in their casinos. S&P was ahead of Fitch’s upgrade, as it upgraded LVS to BBB- from BB+ in July 2022 for very similar reasons: accelerating recovery in Macao’s cash flows.

FebruaryLas Vegas Sands CorpBB1LeisureGaming3.1293.19

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: Retail exposure jumped to 17% with the addition of AAP into the index, while the Leisure sector’s exposure was cut almost in half after LVS’ exit. Spreads tightened during the month, except for Basic Industry and Services, which saw their spreads widen by 25bps and 3bps, respectively, while all but the Financial and Retail sectors saw their prices increase. In terms of attribution relative to broad high yield, the underperformance was notably influenced by two of the largest sectors, Real Estate and Telecom, while the lack of Media exposure in fallen angels was a contributor.

12/31/20231/31/20242/29/202412/31/20231/31/20242/29/202412/31/20231/31/20242/29/2024MTD
Banking4.794.474.5223121721797.9199.2497.81-0.96
Basic Industry1.701.733.1417115117697.2498.0694.55-0.93
Capital Goods5.855.805.9420022718697.3496.2096.180.42
Consumer Goods4.334.284.3723028426294.2992.5992.08-0.04
Energy14.7514.1713.0825926024592.4992.3791.990.09
Financial Services1.141.081.1337841636486.4184.4485.802.14
Healthcare4.104.164.2427024723988.7389.4388.92-0.09
Insurance1.321.351.3732327025994.1096.4695.49-0.48
Leisure7.908.004.9622820519693.2193.9894.280.24
Real Estate9.0710.739.8367557552582.7283.9581.71-2.31
Retail14.3814.4117.2024223020386.3987.1087.450.11
Services0.640.640.6424321922294.7895.8094.13-1.30
Technology & Electronics6.225.505.5819422020694.1492.8192.08-0.34
Telecommunications13.0012.9613.1836637035792.2291.6890.77-0.36
Transportation2.092.102.1520921018794.9294.8694.35-0.10
Utility8.718.638.6713914614092.1891.7290.29-1.18
Total10010010028528326091.2091.1090.33-0.40

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 fund performance. It is not possible to invest in an index.

Fallen Angels Performance by Rating: Within the fallen angel index, single-Bs outperformed BBs and CCCs, but we continue to pay close attention to the single-B price as the gap to BBs has increased due to the lower duration experienced by lower credits. There have only been two other times where the price of single-B fallen angels was much higher than BBs: January 2009 and March 2020.

12/31/20231/31/20242/29/202412/31/20231/31/20242/29/202412/31/20231/31/20242/29/2024MTD
BB80.5580.5582.3121922120992.4492.3491.60-0.37
B13.4313.4212.4431731830896.4696.3195.62-0.07
CCC5.446.045.251,1301,02294969.4070.0166.80-1.57
CC0.5880976.82
Total10010010028528326091.2091.1090.33-0.40

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 fund 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.

Originally published by VanEck on March 14, 2024.

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Important Definitions and Disclosures

Please note that VanEck may offer investments products that invest in the asset class(es) or industries included in this blog.

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third-party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.

A fallen angel bond is a bond that was initially given an investment-grade rating but has since been reduced to junk bond status.

High yield bonds may be subject to greater risk of loss of income and principal and are likely to be more sensitive to adverse economic changes than higher rated securities.

A rising star is a high yield bond that is upgraded to investment grade.

Duration is an estimate of how much the value of a bond portfolio would be affected by a change in prevailing interest rates. The longer a portfolio’s duration, the more sensitive it is to changes in interest rates.

There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer duration fixed-income securities and during periods when prevailing interest rates are low or negative.

Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors cannot invest directly in the Index.

ICE BofA US High Yield Index (H0A0, “Broad HY Index”), formerly known as BofA Merrill Lynch US High Yield Index prior to 10/23/2017, is comprised of below-investment grade corporate bonds (based on an average of various rating agencies) denominated in U.S. dollars.

ICE US Fallen Angel High Yield 10% Constrained Index (H0CF, “Fallen Angels Index”) is a subset of the ICE BofA US High Yield Index and includes securities that were rated investment grade at time of issuance.

Fallen Angel U.S. High Yield index data on and prior to February 28, 2020 reflects that of the ICE BofA US Fallen Angel High Yield Index (H0FA). From February 28, 2020 forward, the Fallen Angel U.S. High Yield index data reflects that of the ICE US Fallen Angel High Yield 10% Constrained Index (H0CF). Fallen Angel U.S. High Yield index data history which includes periods prior to February 28, 2020 links H0FA and H0CF and is not intended for third party use.

ICE Data Indices, LLC and its affiliates (“ICE Data”) indices and related information, the name “ICE Data”, and related trademarks, are intellectual property licensed from ICE Data, and may not be copied, used, or distributed without ICE Data’s prior written approval. The licensee’s products have not been passed on as to their legality or suitability, and are not regulated, issued, endorsed, sold, guaranteed, or promoted by ICE Data. ICE Data MAKES NO WARRANTIES AND BEARS NO LIABILITY WITH RESPECT TO THE INDICES, ANY RELATED INFORMATION, ITS TRADEMARKS, OR THE PRODUCT(S) (INCLUDING WITHOUT LIMITATION, THEIR QUALITY, ACCURACY, SUITABILITY AND/OR COMPLETENESS).

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future results.

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