A Focus on Quality May Enhance Performance
What can investors learn from this? Both the market’s and credit rating agencies’ assessment of credit quality can have a direct impact on the risk and return of emerging markets sovereign bonds. Credit risk is reflected in credit spreads, and movements in credit spreads can result in changes in overall yield and the current value of an investment. We believe that investment grade emerging markets sovereign bonds, along with a limited allocation to BB rated bonds, may provide a combination of relative stability, attractive yields and the potential for price gains that result from credit improvement, for example through exposure to fallen angel emerging markets countries.
Market Realist – Fallen angels have historically offered higher risk-adjusted returns
As discussed throughout the series, investors seeking to make a tactical allocation to investment-grade (FLTR) bonds but who also want attractive yields and the potential for price gains that result from credit improvement can look at fallen angels. Fallen angels generally hold bonds that are more likely to be upgraded back to investment-grade status.
Fallen angels are originally issued with an investment-grade rating but are subsequently downgraded to non-investment or high yield bond status. Some of the well known fallen angels include ArcelorMittal (MT), JCPenney (JCP), Dell (DELL), and Sprint. As depicted in the above chart, fallen angels have outperformed the high yield market in the last three years and offered a more attractive risk-reward trade-off than the broad high yield bond market.
Market Realist – Case for investing in fallen angels
Investors looking for opportunities in fallen angel bonds can look at the VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL). The ETF seeks to replicate the price and yield performance of the BofA Merrill Lynch US Fallen Angel High Yield Index. The index is comprised of below-investment-grade corporate bonds denominated in US dollars, issued in the US domestic market that were rated investment-grade at the time of issuance. As depicted in the above chart, ANGL outperformed the high yield market in the last three years.
Investors seeking exposure to investment-grade emerging market sovereign bonds, along with a limited allocation to BB-rated bonds can look at the VanEck Vectors EM Investment Grade + BB Rated USD Sovereign Bond ETF (IGEM). IGEM provides access to the higher rated subset of the broad US-dollar-denominated emerging market sovereign bond universe. Emerging market investment-grade sovereign bonds have historically provided higher yields versus similarly rated US-dollar-denominated corporate bonds.