Yields At 8% While Rising Stars Outpace Fallen Angels

Candlestick chart and data of financial market. — tadamichi

Increased yields drove underperformance of fallen angels in September; two new fallen angels (Real Estate and Transportation sectors) entered the Index while the Energy sector saw a rising star.

Fallen angels (as represented by the ICE US Fallen Angel High Yield 10% Constrained Index, “H0CF”) underperformed the broad high yield market (as represented by the ICE BofA US High Yield Index, “H0A0”) by 0.51% in September (-1.67% vs -1.16%) as the 10Y Treasury Rate increased to 4.59 from 4.09 at the end of August, causing longer duration assets to take a hit. Fallen angels have a longer duration than broad HY as they are more reflective of the longer maturities found in the investment grade (IG) space. In September, the change in rates explains more than 100% of the difference in returns, only slightly offset by the spread effects. The story, year to date, is similar as rates have generally increased, especially since March when the 10Y was hovering at 3.50 but is now close to 4.60, as illustrated in the chart below. Carry has also been a negative contributor to fallen angel underperformance, as fallen angels have a lower average yield versus the broad high yield market due to their significantly higher credit quality. However, sector exposures and selection within sectors have both been positive contributors to relative performance, somewhat offsetting the impact of higher rates. In terms of flows, high yield corporates saw another approximate 1.5bn in outflows during September following the approximate $1bn in August. Treasury and ultrashort funds continue to see inflows as the short end of the curve is where investors can find high yields with very low duration and credit risk, amid volatility in rates.

US Treasury Curve

US Treasury

Rising Stars continue to outpace Fallen Angels

This year, the fallen angel index has decreased by approximately 36% due to rising stars, compared to an increase of 14% due to new fallen angels. For context, in 2022 there were 18% of rising stars vs 8% of new fallen angels. The largest rising star this year was OXY (8.69% or approximately $9,975m in face value at the time of exit in May) while the largest fallen angel (excluding Nissan (OTCPK:NSANY), as it entered in March and exited May) was Brandywine (BDN) Operating Partnership (1.87% or approximately $1,655m in face value) this past month. Looking forward, JPMorgan estimates that rising stars will continue to exceed fallen angels in 2024, although to a lesser extent.

Rising Star Candidates Timeframe	Total Debt Outstanding ($bn)
2023	54.27
2024	39.41
2025	3.55
Fallen Angel Candidates Timeframe	Total Debt Outstanding ($bn)
2023	21.70
2024	29.71

Source: JPMorgan.

Ford (F) could be the biggest rising star before the year is over. S&P is expected to review its rating in November with most sell side analysts expecting a rating upgrade (currently capped at 10% of the index).
The high yield universe is expected to contract with more upgrades than downgrades, although the upward ratings (rising stars plus upgrades within the IG bucket) are losing some steam.
There is approximately $10bn of BBB- debt with at least one high yield rating and negative outlook, half of which are in the technology sector. while there is approximately $72bn of BBB- without a high yield rating, but with a negative outlook.

Fallen Angels Overall Statistics: Fallen angels average yield increased by 57bps to 8.02, the highest yield since March 2020, only surpassed by the Global Financial Crisis and briefly in early 2016 when oil price declined amid concerns about China’s economic growth. Fallen angels yield is 95bps above the all-time average while broad HY saw an increase of 46bps, to 8.94, which is near what it was at the beginning of the year and 137bps above the average since December 2003. Credit spreads widened in September after a rather pronounced tightening cycle that began in March following the mini-banking crisis. Fallen angel spreads reached 314 (an increase of 21bps), while broad HY surpassed the 400 mark to 403 (an increase of 18bps), but both spreads are still more than 100bps below their long time average and in line with the short-term averages. The fallen angel market value has continued to decline this year due to rising stars. There were no defaults in September for both indices, however, S&P’s latest Default, Transition and Recovery report states that the number of global corporate defaults jumped to 107 as of August 31, 2023 with the U.S. accounting for 69 defaults. There were 16 defaults in August, the highest August monthly tally since 2009.

	Fallen Angel				Broad HY
	12/31/22	3/31/23	6/30/23	9/30/23	12/31/22	3/31/23	6/30/23	9/30/23
Yield to Worst	7.49	7.08	7.35	8.02	8.98	8.49	8.56	8.94
Effective Duration	5.45	5.30	4.98	4.90	4.04	3.83	3.65	3.64
Full Market Value ($mn)	112,854	114,776	84,590	78,279	1,199,909	1,234,319	1,218,316	1,201,541
OAS	337	325	297	314	481	458	405	403
No. of Issues	212	206	163	159	1,927	1,916	1,870	1,872

Source: ICE Data Services, VanEck. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Broad HY: ICE BofA US High Yield Index. OAS refers to “option-adjusted spread.” Please see definition for this and other terms referenced herein in the disclosures and definitions portion of this blog. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest in an index.

New Fallen Angels: Two fallen angels were added in September, adding 2.22% to the Index market value. Brandywine Operating Partnership was downgraded by Moody’s to Ba1 from Baa3, on the expectation that coverage ratios will remain weak as commercial real estate has seen some difficulties over the past few months. This is the first fallen angel REIT so far this year, and given pressures in commercial real estate due to tighter financial conditions, rising office vacancies and stress in the regional banking sector, it will be interesting to see if more follow. The other fallen angel, Port of Newcastle Investments, is in the transportation sector. It was downgraded by S&P to BB+ from BBB- reflecting elevated levels of debt compared to S&P’s earning projections for the next few years. Despite the Port of Newcastle Investments looking for plans to improve their earnings, S&P believes that the timing of those is very unclear. Over the last six months, Brandywine Operating Partnership posted price returns of approximately +6% while Port of Newcastle Investments posted -5%.

Month-end Addition	Name	Rating	Sector	Industry	% Mkt Value	Price
February	Entegris Escrow Corp	BB1	Technology & Electronics	Electronics	1.39	90.92
March	First Republic Bank (OTCPK:FRCB)	B3	Banking	Banking	0.40	54.63
March	Nissan Motor Acceptance	BB1	Automotive	Auto Loans	2.57	87.19
March	Nissan Motor	BB1	Automotive	Automakers	5.49	92.98
April	Crane NXT (CXT)	BB3	Capital Goods	Diversified Capital Goods	0.24	70.99
April	Rogers Communications (RCI)	BB2	Telecommunications	Telecom – Wireless	0.65	90.35
April	Western Alliance Bancorporation (WAL)	BB1	Banking	Banking	0.44	76.39
August	Associated Banc-Corp (ASB)	BB1	Banking	Banking	0.33	95.69
August	Valley National Bancorp (VLY)	BB1	Banking	Banking	0.33	79.84
September	Brandywine Operating Partnership L.P.	BB1	Real Estate	REITs	1.86	87.29
September	Port of Newcastle Investments Financing Pty Limited	BB1	Transportation	Transport Infrastructure/Services	0.36	82.79

Source: ICE Data Services, VanEck. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Past performance is no guarantee of future results. Not a recommendation to buy or sell any of the names/securities mentioned herein. Index performance is not representative of fund performance. It is not possible to invest in an index.

Rising Stars: One issuer exited the index in September, another energy issuer, Patterson-UTI Energy (PTEN), as S&P upgraded it to BBB- from BB+ and Fitch assigned a assigned a BBB- rating. Both agencies’ IG rating status is based on the financial profile of Patterson UTI Energy following the merger of NexTier Oilfield Solutions, as it creates a leading company in the oil field services with a strong presence in the U.S. Patterson UTI Energy was an energy fallen angel in March 2021, posting -6.00% price return and 5.76% total return over its time in the fallen angel index. Over the last 12 months, it posted a price return of 9.61% vs 3.29% for the broad high yield market. Despite a Patterson-UTI Energy upgrade this past month, all eyes are on Ford for the rest of the year as it was upgraded by Fitch in early September to BBB-, as in their view, supply change issues over the past few years are resolved. The ongoing United Auto Workers (UAW) strike has created uncertainty over the short term, but Fitch expects that the Union will reach an agreement soon. More importantly, S&P is expected to review its Ford rating in November of this year, with most sell side analysts expecting a rating upgrade and thus, its removal from the fallen angel index, reducing the Auto sector’s exposure to 0%.

Month-end Exit	Name	Rating	Sector	Industry	% Mkt Value	Price
February	Autopistas Metropolitanas de Puerto Rico LLC	BB1	Transportation	Transport Infrastructure/Services	0.35	100.49
February	Nokia Corp. (NOK)	BB1	Technology & Electronics	Tech Hardware & Equipment	0.47	97.50
March	Western Midstream (WES)	BB1	Energy	Gas Distribution	5.27	90.44
April	Sprint Capital Corp	BB1	Telecommunications	Telecom – Wireless	4.70	114.25
May	Mattel Inc. (MAT)	BB2	Consumer Goods	Personal & Household Products	0.45	85.32
May	Nissan Motor Acceptance	BB1	Automotive	Auto Loans	2.67	85.12
May	Nissan Motor	BB1	Automotive	Automakers	5.57	88.49
May	Occidental Petroleum Corp.	BB1	Energy	Energy – Exploration & Production	8.69	93.82
June	APA Corp. (APA)	BB1	Energy	Energy – Exploration & Production	3.84	82.69
July	Western Digital Corp. (WDC)	BB1	Technology & Electronics	Tech Hardware & Equipment	0.99	76.97
August	Howmet Aerospace Inc. (HWM)	BB1	Capital Goods	Aerospace/Defense	2.04	99.55
September	Patterson-UTI Energy Inc.	BB1	Energy	Oil Field Equipment & Services	1.07	90.37

Fallen Angels Performance by Sector: Only the services sector posted a positive return for September (+0.81%), but with a small exposure (0.56%), it was not enough to offset the negative performance of the others 16 sectors that compose the fallen angel index. Year to date, the banking sector is the only sector (aside from a -0.01% return of the insurance sector) that posted negative returns, reflective of the stress experienced in that sector this year. Changes in sector exposures have been a theme this year, in particular the decrease in Energy exposure, driven by rising star activity. In September, the real estate sector saw an increase with a new fallen angel, while energy continued its downward trend to below 15%. As of month-end, 9% is trade in the $70s, 66% of fallen angels (up from 63% last month) are now trading in the $80s, 25% (down from 37%) in the $90s and no sector continues to be above par.

	Wgt (%)				OAS				Price				TotalReturn(%)	TotalReturn(%)
	12/31/21	3/31/23	6/30/23	9/30/23	12/31/21	3/31/23	6/30/23	9/30/23	12/31/21	3/31/23	6/30/23	9/30/23	YTD	MTD
Automotive	10.00	18.06	10.00	10.00	262	246	211	206	91.35	92.21	92.99	91.16	3.27	-0.41
Banking	3.81	3.99	3.20	4.34	302	415	376	279	96.85	87.61	88.57	92.02	-3.40	-0.52
Basic Industry	1.36	1.33	1.93	1.92	226	227	168	178	92.17	93.85	94.44	93.53	5.06	-0.88
Capital Goods	5.12	5.10	7.66	5.86	279	240	195	250	95.01	98.54	96.85	92.44	4.35	-1.41
Consumer Goods	3.07	3.00	3.62	3.82	275	255	298	271	88.90	91.27	89.31	88.24	3.16	-3.23
Energy	27.93	22.16	15.28	14.45	293	303	297	288	88.13	90.05	88.74	87.48	6.08	-1.56
Financial Services	0.65	0.64	0.94	0.98	540	506	459	420	77.20	80.27	80.92	79.51	7.65	-2.50
Healthcare	3.02	3.03	4.33	4.62	362	304	281	299	83.56	86.47	86.82	84.72	5.51	-1.55
Insurance	0.85	0.82	1.15	1.20	347	364	358	366	92.10	92.99	91.39	87.81	-0.01	-1.22
Leisure	7.88	7.79	10.42	7.87	325	243	182	257	89.95	93.25	93.34	89.37	6.56	-1.28
Real Estate	5.13	4.72	6.22	8.37	697	701	602	660	79.46	80.72	80.99	80.86	6.26	-3.23
Retail	5.67	5.49	7.79	7.98	471	474	354	368	73.75	74.72	82.35	78.48	3.65	-3.26
Services	0.38	0.37	0.53	0.57	388	368	356	309	87.11	89.89	88.62	88.75	6.14	0.81
Technology & Electronics	4.20	4.67	6.21	5.57	327	287	269	262	85.47	88.19	86.89	87.23	4.62	-2.06
Telecommunications	11.91	11.68	10.61	11.53	423	433	475	418	90.04	91.39	84.92	84.95	9.16	-1.01
Transportation	2.10	1.78	2.59	3.14	279	231	150	203	90.49	92.69	94.75	91.70	7.46	-1.70
Utility	6.93	5.38	7.52	7.77	213	206	165	175	89.95	90.19	89.90	86.28	1.19	-2.04
Total	100	100	100	100	337	325	297	314	87.91	89.51	88.78	86.69	4.46	-1.67

Source: ICE Data Services, VanEck. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Not intended as a recommendation to invest or divest in any of the sectors mentioned herein. Index performance is not representative of fund performance. It is not possible to invest in an index.

Fallen Angels Performance by Rating: Single-B rated issuers outperform BB and CCC & lower rated issuers in September. As we wrote last month, CCC & lower rated issuers have outperformed YTD due to robust U.S. growth data and better-than-expected earnings. Diversified Healthcare Trust (DHC), a REIT, is the CC rated issuer (upon Moody’s downgrade to Ca in early September) following the notice that the merger between DHC and Office Properties Income Trust (OPI) was cancelled.

	Wgt (%)				OAS				Price				TotalReturn(%)	TotalReturn(%)
	12/31/21	3/31/23	6/30/23	9/30/23	12/31/21	3/31/23	6/30/23	9/30/23	12/31/21	3/31/23	6/30/23	9/30/23	YTD	MTD
BB	87.00	87.08	83.01	81.02	284	281	256	257	90.02	91.51	89.83	87.94	3.62	-1.75
B	10.95	10.37	13.31	15.03	608	500	405	493	82.50	85.35	89.55	86.37	5.99	-0.88
CCC	1.98	2.50	3.68	3.43	1,020	1,014	852	810	60.88	64.60	68.55	67.01	21.94	-2.88
CC				0.52				835				72.91
C^*		0.04				6,713				7.16			-17.77
D^*	0.07				4,726				10.00				-62.06
Total	100	100	100	100	337	325	297	314	87.91	89.51	88.78	86.69	4.46	-1.67

Source: ICE Data Services, VanEck. ^*Does not have securities for all months of selected period. Returns are based on partial period data. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest in an index.

Important Definitions and Disclosures

Please note that VanEck may offer investments products that invest in the asset class(es) or industries included in this blog.

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities, financial instruments or digital assets mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, tax advice, or any call to action. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results, are for illustrative purposes only, are valid as of the date of this communication, and are subject to change without notice. Actual future performance of any assets or industries mentioned are unknown. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its other employees.

A fallen angel bond is a bond that was initially given an investment-grade rating but has since been reduced to junk bond status.

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.

A rising star is a high yield bond that is upgraded to investment grade.

Duration is an estimate of how much the value of a bond portfolio would be affected by a change in prevailing interest rates. The longer a portfolio’s duration, the more sensitive it is to changes in interest rates.

There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer duration fixed-income securities and during periods when prevailing interest rates are low or negative.

Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors cannot invest directly in the Index.

ICE BofA US High Yield Index (H0A0, “Broad HY Index”), formerly known as BofA Merrill Lynch US High Yield Index prior to 10/23/2017, is comprised of below-investment grade corporate bonds (based on an average of various rating agencies) denominated in U.S. dollars.

ICE US Fallen Angel High Yield 10% Constrained Index (H0CF, “Fallen Angels Index”) is a subset of the ICE BofA US High Yield Index and includes securities that were rated investment grade at time of issuance.

Fallen Angel U.S. High Yield index data on and prior to February 28, 2020 reflects that of the ICE BofA US Fallen Angel High Yield Index (H0FA). From February 28, 2020 forward, the Fallen Angel U.S. High Yield index data reflects that of the ICE US Fallen Angel High Yield 10% Constrained Index (H0CF). Fallen Angel U.S. High Yield index data history which includes periods prior to February 28, 2020 links H0FA and H0CF and is not intended for third party use.

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Rising Stars continue to outpace Fallen Angels

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