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Fallen angel bonds are feeling the influence of U.S. monetary policy and the geopolitical environment. Credit quality and sector weights have been key performance drivers so far in 2018 while somewhat offsetting one another. Fallen angel bond performance is mainly driven by higher average credit quality, sector differentiation, and potential value from discounted bonds as they are downgraded to high yield status.
Fallen angel bonds underperformed the broad high yield bond market1 by 0.5%, as of May 31, 2018 (-1.2% vs. -0.7%, respectively). After a strong start in January, their current 74% concentration in BB-rated bonds2 and associated interest rate duration3 proved challenging in the face of the Federal Reserve’s tightening monetary policy. Instead the lower duration, lower correlation single-Bs and CCCs have been the high yield outperformers since the end of 2017. Top fallen angel sector contributors year to date have been the overweight in energy and underweight in media. Main detractors have been positions and overweights in the basic industry (e.g., materials) and telecom sectors.
Credit spreads remain near multi-year lows at 363 points4, ending May only 5 points wide versus the start of the year. Meanwhile, the U.S. 10-year interest rate broke through 3% in April – a high not seen since 2011. The more comparable rate for high yield bonds is the U.S. 5-year interest rate, which was up 46 basis points year to date at 2.66% and closing as high as 2.93% – a level not seen since 2009.
In this environment of modest overall moves in credit spreads and consistently rising interest rates, fallen angels’ higher quality composition has weighed on returns. However, when credit markets have deteriorated – i.e., when credit spreads widened significantly – the higher average BB-concentration has also historically resulted in less downside than the broader high yield bond market with its average 40% BB-concentration.
Fallen Angel High Yield Bonds Offered Less Downside When Credit Markets Deteriorated
Source: FactSet. Data as of May 31, 2018. Past performance is no guarantee of future performance. Index performance is not indicative of fund performance. Indices are not securities in which investments can be made. See index descriptions and additional disclosures below. Blue and orange shading represents annual change in credit spreads. Credit spreads presented are the option adjusted spreads between high yield bonds and their comparable U.S. treasuries.
While not always the case, fallen angel bonds have tended to outperform the broad high yield bond market, on average, in calendar years when credit spreads widened meaningfully, as well as in the subsequent recovery periods. The chart above shows fallen angel bonds outperforming broad market high yield bonds three out of the last six calendar years when credit spreads have widened.
This was most acutely seen in 2008, when fallen angels outperformed by 2.6% (-25.8% vs. -28.4%) as credit spreads widened by 1,212 points, and again in 2015 (-3.2% vs. -5.3%) when spreads widened by 191 points. Both 2008 and 2015 are instances that reflected value proposition as a key driver of returns, as these years represented the largest volumes of discounted fallen angel entrants, historically.
During the three calendar years in the chart above when fallen angel bonds underperformed the broad high yield bond market, the average relative return was -1.6%. This compares with the average +3.6% relative return in years with outperformance, helping to illustrate the strategy’s historical effectiveness.
Fallen angels’ largest sector overweights relative to the broad high yield bond market are in the basic industry (e.g., materials) and energy sectors. As such, the fallen angel ETF and index tends to have greater sensitivity to commodity price movements.
In May, oil prices reached highs not seen since 2014, making the fallen angel energy sector the top performer year to date. Meanwhile, escalating trade tensions over potential tariff policies have contributed to price declines in materials. Fallen angels’ overweight in the basic industry sector has been the major driver of underperformance relative to the broad high yield bond market year to date.
More price volatility in commodity sectors may ensue with increasing or subsiding trade tensions. Oil prices are likely to be responsive in the days leading up to and after the June OPEC meeting, when future output may be determined. However, despite these headline risks, fallen angels’ two largest sector biases may appeal to investors positively disposed to commodities for their potential diversification and pro-inflationary features.
U.S. Treasuries Yield Curve’s Flattening Trend
12/31/2016 – 5/31/2018
Source: FactSet. Data as of May 31, 2018. Past performance is no guarantee of future performance.
The Fed increased rates this month and signaled that additional hikes are coming in the second half of the year, raising concern over the flattening yield curve and its potential implications. Should markets deteriorate and decline, a fallen angel ETF presents a higher quality option for high yield investors to consider. Lower rated high yield bonds have tended to deteriorate more than higher rated high yield bonds when credit spreads widened significantly. In addition, a declining credit market could precipitate new fallen angel entrants, which may present new value opportunities for this strategy.
VanEck Vectors® Fallen Angel High Yield Bond ETF (ANGL®) Consistently Outperformed Peers5
Source: Morningstar. Data as of March 31, 2018.
Click here to view ANGL performance current to most recent month end.
This chart is for illustrative purposes only. The performance data quoted represents past performance. Past performance is not a guarantee of future results. Performance information for the Fund reflects temporary waivers of expenses and/or fees. Had the Fund incurred all expenses, investment returns would have been reduced. Investment return and value of the shares of the Fund will fluctuate so that an investor's shares, when sold, may be worth more or less than their original cost. Performance may be lower or higher than performance data quoted. Fund returns reflect dividends and capital gains distributions. VanEck Vectors Fallen Angel High Yield Bond ETF commenced on April 10, 2012. An investor cannot invest directly in an index. The results assume that no cash was added to or assets withdrawn from the Index. The high yield bond peers category is represented by the Morningstar Open End Funds – U.S. – High Yield Bond category. See index descriptions below.
VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) received an overall five-star rating within the Morningstar high yield bond category based on total return as of May 31, 2018.6 Past performance is no guarantee of future results. Additional resources and information on VanEck Vectors Fallen Angel High Yield Bond ETF .
IMPORTANT DEFINITIONS AND DISCLOSURES
Source of all data unless otherwise noted: FactSet. Data as of March 31, 2018.
1Fallen angels are high yield corporate bonds that are originally issued with investment grade credit ratings, and are represented by the ICE BofAML US Fallen Angel High Yield Index (H0FA Index, fallen angel Index, fallen angels). The “broad high yield bond market” is represented by the Bloomberg Barclays High Yield Very Liquid Index.
2Composite ratings are based on the simple averages of ratings from Moody's, S&P, and Fitch. This composite is not intended to be a credit opinion. Investment grade bonds are rated AAA to BBB (high to medium credit quality). Below-investment grade bonds have credit ratings of BB, B, and CCC, and have lower credit quality.
3Duration is a measure of the price sensitivity of a debt instrument to interest rate changes. It approximates the percentage decline in price returns for a 1% increase in market interest rate.
4Credit spread is the difference in yield between two bonds of similar maturity but different credit quality. For example, the yield of a 5-year corporate bond with a yield of 5% may be compared to the yield of a 5-year U.S. note with a yield of 2%, resulting in a 300 basis point credit spread. When credit spreads are narrowing (or tightening), the yield spreads get closer and would typically mean that credit markets are improving. When credit spreads are widening, the yield spreads grow further apart and would typically mean that credit markets are deteriorating.
5Source: ©Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The peer group chart presents trailing total return percentile rankings against the Morningstar Open End Funds – U.S. – High Yield Bond category, which comprised 704 mutual funds as of March 31, 2018.
6Morningstar ratings: ©Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating™ based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund's monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.) The Overall Morningstar Rating for a fund is derived from a weighted average of the performance figures associated with its three-, five- and ten-year (if applicable) Morningstar Rating metrics. As of May 31, 2018, ANGL was rated against 584 and 490 high yield bond funds over the last three- and five-years, respectively. ANGL received a Morningstar Rating of 5 stars for the 3-year, 5-year, and overall rating. Past performance is no guarantee of future results.
Morningstar Open End Funds – U.S. – High Yield Bond category is comprised of open-end mutual funds with an investment objective to seek returns via significant exposure to low quality bonds, those that are either unrated or rated by a major agency as BB or lower.
Morningstar U.S. High Yield Bond category average is comprised of exchange-traded and open-end mutual funds with an investment objective to seek returns via significant exposure to low quality bonds, those that are either unrated or rated by a major agency as BB or lower.
This content is published in the United States for residents of specified countries. Investors are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this content. Nothing in this content should be considered a solicitation to buy or an offer to sell shares of any investment in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction, nor is it intended as investment, tax, financial, or legal advice. Investors should seek such professional advice for their particular situation and jurisdiction.
The information herein represents the opinion of the author(s), but not necessarily those of VanEck, and these opinions may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
The indices listed are unmanaged indices and do not reflect the payment of transaction costs, advisory fees, or expenses that are associated with an investment in any underlying exchange-traded funds. Certain indices may take into account withholding taxes. Index performance is not illustrative of fund performance. Fund performance current to the most recent month end is available by visiting vaneck.com. Historical performance is not indicative of future results; current data may differ from data quoted. Indexes are not securities in which an investment can be made.
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).
ICE BofAML US Fallen Angel High Yield Index (H0FA) is a subset of the ICE BofAML US High Yield Index (H0A0), including securities that were rated investment grade at time of issuance. Performance and characteristics of the ICE BofAML US Fallen Angel High Yield Index (H0FA) are quoted throughout this material. H0FA is not representative of the entire fallen angel high yield corporate bond market. H0FA does not represent the performance or yield of the VanEck Vectors Fallen Angel High Yield Bond ETF.
Barclays US High Yield Very Liquid Index is a more liquid version of the Barclays Capital US Corporate High-Yield Index that measures the market of USD-denominated, non-investment grade, fixed-rate, taxable corporate bonds. Qualifying issues must have been issued within the past three years, have a USD 600 million minimum amount outstanding and include only the largest issue from each issuer.
Bloomberg Barclays Indices does not sponsor, endorse, or promote the Fund and bears no liability with respect to the Fund or security.
Fund shares are not individually redeemable and will be issued and redeemed at their net asset value (NAV) only through certain authorized broker-dealers in large, specified blocks of shares called "creation units" and otherwise can be bought and sold only through exchange trading. Shares may trade at a premium or discount to their NAV in the secondary market. You will incur brokerage expenses when trading Fund shares in the secondary market. Past performance is no guarantee of future results. Returns for actual Fund investments may differ from what is shown because of differences in timing, the amount invested, and fees and expenses.
An investment in the Fund may be subject to risk which include, among others, credit risk, call risk, and interest rate risk, all of which may adversely affect the Fund. 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. International investing involves additional risks which include greater market volatility, the availability of less reliable financial information, higher transactional and custody costs, taxation by foreign governments, decreased market liquidity and political instability. The Fund's assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.
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