Great year for fallen angels

Fallen angels are bonds downgraded from investment grade to high yield. Due to the structural divide between investment grade and high yield investors, fallen angels has historically outperformed its high yield peers [Fallen Angels: The last free lunch? (dnbam.com)]. 2020 was no exception and the outperformance was amplified by the FED.

On March 23rd, FED announced the creation of bond buying facilities to improve market liquidity. Through the Primary Market Corporate Credit Facility (PMCCF) new issues would be purchased, while secondary market bonds and ETFs would by purchased through the Secondary Market Corporate Credit Facility (SMCCF). The intention was to provide credit to employers, so they were better able to maintain operations during the pandemic dislocation. Originally, only investment grade rated issuers were eligible, but on April 9th it was announced that certain fallen angles, that were investment grade as of March 22nd, as well as ETFs with exposure towards high-yield U.S. corporate bonds, were included. This significantly improved liquidity and worked as a strong stabilizing force.

Measured by Bloomberg Barclays Global Fallen Angels- and Global High Yield Indices, fallen angels outperformed the broader high yield market with around 11 percent in 2020. New fallen angels were important contributors and examples of such are Ford and Carnival Cruise Lines (CCL), both of which are included in our Fallen Angel Reversal strategy and part of our Multi-Asset fund. Our Fallen Angel Reversal strategy has returned ca. 14 percent since its inception in February 2020.

Ford were included in the Bloomberg’s Global Fallen Angels index in April 2020 and their longest bond, the 2046 maturity has since returned around 90 percent. A high cash burn from closed factories together with forecasted drop in sales were triggers for the downgrade. CCL were downgraded because of the pandemic's impact on travel, included in the index in June 2020 and their longest bond, the 2029 maturity has since returned 20 percent. Despite this stellar performance since index inclusion these bonds, both now trading at around 4.6 percent yields still offer good value compared to the broader market.

Furthermore, both Ford and CCL are good examples of a recent trend. As the pandemic has worsened many balance sheets, there has been a massive issuance of corporate bonds to protect liquidity, made possible by FED and other central banks. This issuance could however be detrimental to leverage ratios, which in turn can lead to more downgrades. An increase in downgrades can impact supply/demand and lead to greater price distortions while making the fallen angel universe more diversified at the same time. If this materializes, the potential for attractive risk-return increases in our fallen angel strategy.

We now focus on the recovery and expected rebound in activity in 2021. Vaccines are being rolled out and although there are some initial disappointments with respect to the speed and breadth of vaccination as well as some fears related to virus mutations the data so far indicates that the vaccines will prove highly successful. Although markets are already pricing a benign scenario there is still substantial potential for spread tightening and good returns in 2021.

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