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Investors Look to Fallen Angel High Yield Bonds for Value

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Example of Fallen Angel Bond from Nokia

An example of a fallen angel in which the market acknowledged its value proposition is Nokia, which became a fallen angel in April 2012. Nokia’s established brand and infrastructure helped attract the attention of Microsoft, which completed its acquisition of Nokia’s Devices & Services business, licenses to Nokia’s patents, and license and use of Nokia’s mapping services on April 25, 2014, for $7.5 billion.[3. http://www.microsoft.com/en-us/news/press/2013/sep13/09-12announcementpr.aspx, http://www.cnbx.com/id/101613826]

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Source: FactSet. Data as of March 31, 2016. Historical performance is not indicative of future results; current data may differ from data quoted.

The September 2, 2013, acquisition announcement caused the Nokia 5.375% 15-May-2019 issue’s price to appreciate from $95.25 to $101.50 in a single day.  As of March 31, 2016, the bond made up 0.56% of VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) and continued to trade at a premium: $107.00.  While not always the case, news of an acquisition has tended to have an immediate, positive influence on bond price performance, as illustrated above.

Characteristics

While currently yielding less than original-issue high yield bonds, on average, mainly as a result of a relatively higher rated credit composition, a portfolio of fallen angels presents an interesting value proposition given the trends listed above. It should also be noted that, on average, fallen angels currently have higher interest rate sensitivity than the broad high yield bond market. However, other factors can influence performance during rising rate environments. As illustrated above, fallen angels had outperformed the broad high yield bond market in 2004, 6, 9, and 13 – years when interest rates rose approximately one percent or more.[4. Source: Factset. Based on the Federal Reserve’s federal funds rate or 5-year U.S. Treasury rate rising approximately one percent or more since H0FA’s inception on December 31, 2003.]

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Source: FactSet. Data as of March 31, 2016. Historical performance is not indicative of future results; current data may differ from data quoted. Indexes are unmanaged and are not securities in which an investment can be made.

VanEck Vectors Fallen Angels High Yield Bond ETF (ANGL), the first-of-its-kind U.S. listed ETF, offers high yield investors this differentiated asset class.

Index Characteristics

As of March 31, 2016

Index

Current Yield to Worst

Modified Duration

Market Value ($Mil)

# of Bonds in Index

% of Fallen Angels

BofAML US Fallen Angel

7.70

5.52

184,122

402

100%

BofAML US High Yield

8.39

4.63

1,262,197

2,327

15%

Credit Composition of High Yield Indices (%)

As of March 31, 2016

BofAML US Fallen Angel

BofAML US High Yield

BofAML US Original Issue High Yield

BB

81.5

49.9

44.5

B

14.7

36.6

40.3

CCC

3.5

12.6

14.2

CC

0.1

0.6

0.7

C

0.3

0.2

0.2

Source: FactSet. Data as of March 31, 2016. Yield to Worst is generally defined as being the lowest yield that a buyer can expect to receive. Modified Duration measures the responsiveness of a bond’s price to interest rate changes. It is defined as the percentage change in price for a 100 basis point change in interest rate.

Market Realist – The start of 2016 has been marked by an increase in the quantum of fallen angel bonds in the high-yield bond market (HYG) (JNK). According to Citi Research, Standard & Poor’s already downgraded credit ratings for more companies in 1Q16 than it did in all of 2015. Most of the additions to fallen angel bonds are from the energy (XLE) and commodity sector. Currently, energy accounts for 25% of the fallen angel index—a staggering increase from the estimate of 5% at the beginning of 2015 (Source: Barron’s). As a result, the rebound in oil prices (USO) helped fallen angel bonds in a big way. The energy sector’s impact has been more pronounced on fallen angel bonds than the high-yield bond index. The high-yield bond index has 13% exposure to the energy sector. Rallying oil prices could continue. They will likely be a major tailwind for fallen angel bonds in the year ahead.

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As we discussed in the previous part of the series, credit quality is a major plus when it comes to choosing between fallen angel bonds and high-yield bonds. According to a VanEck Vectors note, the VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL) consists of 73.9% BB rated debt. This is the upper-end of junk-rated debt. The iShares iBoxx High Yield Corporate Bond ETF (HYG) only accounts for a 49.8% weight to BB-rated debt (Source: etftrends). The higher credit quality doesn’t mean skimping on yield. The 30-day SEC yield for the ETF is 7.3% (Source: VanEck Vectors). As a result, the risk-adjusted returns of ANGL tend to be higher compared to the broader junk bond market.

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Recently, ANGL topped $100 million in assets. It nearly doubled in size in less than three months (Source: Business Wire). ANGL’s solid performance can be attributed to the higher-than-average allocations to the basic industry (~17%) and energy (~13%) sectors. They improved and outperformed in 1Q16. The above graph shows the top and bottom three sector attributions of the BofA Merrill Lynch US Fallen Angel High Yield Index for fallen angel bonds versus the BofA Merrill Lynch US High Yield Index for the broad high-yield bond market.

ANGL could prove to be a great value addition to fixed income portfolios.

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