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Spreads in Control

Fallen angels outperformed broad high yield by 0.24% in March and 0.10% YTD, due in part, to tighter spreads. Q1 2024 saw two fallen angels and two rising stars.

In March, fallen angels (as represented by the ICE US Fallen Angel High Yield 10% Constrained Index, “H0CF”) outperformed the broad high yield market (as represented by the ICE BofA US High Yield Index, “H0A0”) by 0.24% (1.43% vs to 1.19%), and year-to-date, they are leading by 0.10%, with returns of 1.61% vs 1.51% for the broad high yield market.The majority of this outperformance can be attributed to tighter credit spreads, as fallen angel spreads tightened by 38bps compared to 24bps for the broad high yield. The impact offset the rise in bond yields. Hotter than expected inflation and jobs numbers so far this year have driven a re-pricing of market expectations for rate cuts to better align with U.S. Federal Reserve (Fed) guidance and some are now wondering if there could be no rate cuts at all this year. Longer term bond yields have moved upwards and as a result, yields on fallen angels (currently approximately 7%) remain significantly higher than historical averages despite the tightening of spreads over the past six months.

Spreads Drive Outperformance

The price return of fallen angels has historically served as a significant distinguishing factor compared to the broad high yield market from a total return perspective. Bonds that experience downgrades to high yield often undergo a recovery in the subsequent months following the rating adjustments. Typically, a higher volume of downgrades correlates with higher returns, as evidenced during events like the COVID-19 pandemic or the oil crisis of 2016. However, over the past few years, the strong credit environment has led to a dearth of new fallen angels, and the higher duration of fallen angels has driven a lag in price returns versus the broad HY market over the 1-year and 3-year periods. This has been offset, to a degree, by positive price performance of a significant number of “rising stars” over the period. The higher quality of fallen angels has also been a return detractor relative to the broad market, given the strong risk-on environment we’ve seen recently and the generally lower yields of the segment.

More recently, fallen angels have outperformed broad HY, following the pause of the Fed’s hiking campaign in the summer of 2023 and the rise in bond yields over the past 3 years subsiding. Although bond yields remain elevated and we expect to continue to see bouts of rate volatility (similar to what we’ve seen recently), we generally expect long term yields to be range bound over the next year or so. Rate cuts down the road provide the potential for a duration tailwind, although we are generally expecting yield curve normalization rather than a significant decline in long-term bond yields, at least based on the current macro environment.

As the Fed contemplates rate cuts sometime this year, high yield investors should not focus solely on every data point the Fed considers but rather acknowledge that rate cuts are likely coming, and what the impact on the asset class may be. Historically, once the Fed initiates its easing cycle, BB-rated bonds have demonstrated outperformance (as discussed in our 2024 outlook) within high yield.

Cumulative Price, Income and Total Return

PriceIncomeTotalPriceIncomeTotalDifference
3m0.20%1.41%1.61%-0.11%1.62%1.51%0.31%
6m7.07%3.08%10.15%5.22%3.46%8.68%1.85%
9m5.13%4.59%9.72%4.07%5.18%9.25%1.06%
1Y4.82%6.12%10.95%4.08%6.96%11.04%0.75%
3Y-9.56%15.96%6.39%-11.08%17.85%6.77%1.52%
5Y0.90%31.30%32.20%-10.05%31.89%21.84%10.95%
10Y6.23%82.52%88.75%-18.38%71.65%53.27%24.61%

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 dipped 17bps to 6.92% in March, but are overall flat so far this year while spreads keep trending downwards, finishing Q1 at 247bps. We haven’t been at these levels since January 2022 when the average spread reached 204bps. Given that inflation and interest rates are likely to remain elevated for longer, with the 10Y rising to 4.20% from 3.88% at the end of last year, we believe investors may capitalize on the advantages of the relatively high yields and attractive credit fundaments within the higher quality segments in high yield. Regarding defaults, the broad high yield market witnessed two issuers default in March: Enviva and Curo Group ($1,750 million par outstanding), adding to Cano Health and Audacy Capital Corp for a total of $3,044m vs $0 for fallen angels.

12/31/20233/31/202412/31/20233/31/2024
Yield to Worst6.996.927.697.75
Effective Duration5.415.323.313.28
Full Market Value ($mn)67,82164,6571,237,7211,260,542
OAS285247339315
No. of Issues1431381,8371,864

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: There were no new fallen angels in March, and a total of two in the first quarter of 2024. We continue to monitor issuers that may be impacted by commercial real estate exposure. S&P downgraded five regional bank (First Commonwealth Financial, M&T Bank, Synovus, Trustmark Corp and Valley National Bancorp) outlooks due to their real estate exposure and the continuing challenges within the space, especially in the office property market as office vacancy rates hit an all-time high of 19.6% at the end of 2023, according to Moody’s Analytics. Outside of real estate, Moody’s placed Boeing’s Baa2 rating on review for downgrade as they believe Boeing will be unable to deliver enough planes to maintain free cash flow, but the company remains multiple notches away from high yield. Closer to fallen angel status is Paramount Global, as both S&P and Fitch downgraded it (Fitch to BBB- from BBB;S&P to BB+ from BBB-) citing continued cord cutting and elevated costs of building their streaming services.

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: Enlink Midstream exited the index in March, after joining in July 2018 at $90.71, as S&P upgraded it to BBB+ from BB+ due to a significant reduction of its leverage over the past several years. During its time in the fallen angel index, Enlink provided a price return of -1.98% but a total return of approximately +45% vs the energy sector at approximately +11%.

FebruaryLas Vegas Sands CorpBB1LeisureGaming3.1293.19
MarchEnlink Midstream Partners LPBB1EnergyGas Distribution2.3088.92

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 within fallen angels is now 18% (an increase of more than 3% YTD) while Energy sector exposure is now close to 11% (a decrease of more than 3%), after Enlink exited the index. Leisure exposure was cut in half during the quarter after LVS exited in February. In terms of spreads, all sectors except Banking, Basic Industry and Telecom saw their spreads tighten YTD, with the Real Estate sector now 148bps tighter than at the beginning of the year but still above 500bps. In terms of attribution relative to broad high yield, the outperformance so far this year was notably influenced by fallen angels being overweight Retail (almost 3x) and the lack of Media exposure. Fallen angels underweight to Basic Industry and Services detracted the most during Q1.

12/31/233/31/2412/31/233/31/2412/31/233/31/24MTDYTD
Banking4.794.6223123597.9197.11-0.240.48
Basic Industry1.703.2017118697.2494.370.240.53
Capital Goods5.856.1720015397.3497.381.661.35
Consumer Goods4.334.4223022394.2993.071.540.20
Energy14.7511.1725923592.4993.951.582.31
Financial Services1.141.1837833686.4187.092.012.40
Healthcare4.104.4427021088.7390.802.553.75
Insurance1.321.4332324494.1096.821.904.46
Leisure7.905.1022817093.2195.081.252.71
Real Estate9.079.6067552782.7281.841.440.82
Retail14.3818.0224217986.3989.542.774.06
Services0.640.6624321794.7894.510.841.02
Technology & Electronics6.225.8119418894.1492.991.420.76
Telecommunications13.0013.3936636892.2290.01-0.20-0.52
Transportation2.092.2320917094.9295.371.491.76
Utility8.718.5413912292.1891.131.550.23
Total10010028524791.2091.221.431.61

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 and in the general broad high yield market, CCC and lower rated issuers continue to outperform their higher rated peers as they’ve had better than expected earnings. For context, CCC and lower rated bonds (as the ICE BofA CCC & Lower US HY Index) have outperformed the broad HY market 12 times in the last 16 months and YTD, CCC and lower rated bonds are up 3.22% vs 1.51% for the broad market.

12/31/233/31/2412/31/233/31/2412/31/233/31/24MTDYTD
BB80.5581.6321919092.4492.851.541.78
B13.4312.8731733096.4693.990.000.30
CCC5.445.511,13089369.4068.483.161.96
CC*0.5880976.822.47
Total10010028524791.2091.221.431.61

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. 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 April 17, 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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