What is a fallen angel?
In the investment world, a fallen angel is a bond that was initially given an investment grade rating but has since been reduced to junk bond status. The downgrade is caused by the worsening financial condition of the issuer.
The term is sometimes used to describe a stock that has fallen sharply from a record high.
Explanation of the fallen angel
Fallen Angel Bonds have been downgraded by one of the major rating services such as Standard & Poor’s, Fitch and Moody’s Investors Service. They can be corporate, local government, or sovereign debt.
- A fallen angel is a bond that is junk because the issuer is in financial difficulty.
- The bond pays a higher return than an investment-quality bond, but at a higher risk.
- Some bond funds and ETFs focus on fallen angels.
The main reason for the downgrade is a decline in earnings, which jeopardizes the issuer’s ability to pay interest on bonds. The combination of lower revenues and higher debt dramatically increases the likelihood of downgrades.
Corrupted Angel Securities are often attractive to opposition investors who are trying to take advantage of the potential for businesses to recover from a temporary setback. In these situations, the downgrade process usually begins with the company’s debt being placed under negative credit oversight. That alone forces many portfolio managers to sell their positions.
Junk status promotes sales
The actual downgrade to junk status increases sales pressure, especially from funds that are limited to holding investment grade bonds. As a result, fallen angel bonds can only offer value within the high yield category if the issuer seems reasonably likely to recover from the conditions that caused the downgrade.
Fallen Angel Fund
There are even fallen angel bond funds for investors who have found a fire sale opportunity. VanEck Vectors Fallen Angel High Yield Bond ETFs only invest in downgraded bonds. As of September 2021, its holdings included bonds from Sprint Capital Corp., Vodafone Group PLC, Freeport McMoran and others. As the name implies, there are also iShares Fallen Angel USD Bond ETFs that invest only in dollar-denominated fallen angels.
Risk of investing in a fallen angel
Oil companies that report losses for several quarters due to falling oil prices could downgrade investment grade bonds to junk bonds due to the increased risk of default. As a result of the downgrade, the price of the company’s bonds will fall and the yield will rise. This makes it attractive to opposition investors who see low oil prices as a temporary condition.
Municipal bonds in problematic cities with reduced tax revenues are at risk of being downgraded.
Some fallen angels never come back. For example, if a product that is better than your company hits the market, your company will experience a decline in revenue. If a company fails to innovate, it won’t come back. The transition from VCR tapes to DVDs and streaming videos is one example.
Local governments and sovereign debt issuers may also downgrade investment grade bonds to junk status due to a combination of stagnant or declining tax revenues and rising debt levels. These conditions can create a downward spiral towards default as debt repayments cut into lower incomes and more bonds are issued to make up for the shortfall.
Sooner or later, the municipality or national government will miss the payment.