How Do You Identify a Fallen Angel?

In investing, a bond that was formerly rated as an investment-grade bond but was later downgraded to junk bond classification is known as a “fallen angel.” The issuer’s financial situation has gotten worse, which is the reason for the downgrade.

The phrase may also characterize a stock that has sharply declined from its peak.

The Meaning of Fallen Angel

One of the three leading rating agencies, Standard & Poor’s, Fitch, and Moody’s Investors Service, has downgraded fallen angel bonds. They might be national, municipal, or corporate debt.
A downgrade primarily results from a decline in revenue, which jeopardizes the issuers’ ability to pay bond interest. A downgrade is far more likely if there is a combination of falling incomes and rising debt levels.

For investors willing to take a chance and believe that a firm can overcome a little setback, fallen angel securities can be pretty appealing. When this happens, the company’s debt is often put on a negative credit watch, which initiates the downgrading process. Because of this, many portfolio managers are forced to liquidate their holdings since their governing policies might not allow it.

Junk Status Motivates Sales

More selling pressure is generated by the downgrade itself to junk status, especially from funds limited to holding only investment-grade debt. Fallen angel bonds may, therefore, be valuable in the high-yield market, but only if the issuer seems to have a good chance of overcoming the circumstances that led to the downgrading.

Funds for Fallen Angels

For investors who see an opportunity during a fire sale, there are even fallen angel bond funds available. The bonds that the VanEck Vectors Fallen Angel High-Yield Bond ETF invests in are all downgraded bonds. Its assets as of September 2021 comprised bonds from Freeport McMoran, Vodafone Group PLC, and Sprint Capital Corp. Additionally, there is the iShares Fallen Angels USD Bond ETF, which exclusively makes investments in fallen angels denominated in dollars, as the name implies.

Investing in Fallen Angels: The Risks

An oil company’s investment-grade bonds may be reduced to junk status due to the company’s heightened default risk if it has recorded sustained losses over many quarters as a result of declining oil prices. The downgrading will cause the bond prices of the corporation to drop and its rates to rise. For contrarian investors who view low oil prices as a transitory state, this makes them appealing.
Not all fallen angels return. For instance, if a better product than theirs hits the market, a company’s sales will decline. The firm won’t survive if it doesn’t innovate. One example is the shift from VCR cassettes to DVDs to streaming video.

Municipal and sovereign investment-grade bonds may be downgraded to junk status due to mounting debt and sluggish or falling tax receipts. If debt repayments reduce income and more bonds are issued to make up the deficit, a default may result.

That local or federal government will eventually be behind on a payment.

Conclusion

• A fallen angel bond is one whose issuer has experienced financial difficulties, resulting in the bond being downgraded to junk status.
• Although riskier, its bonds provide larger yields than investment-grade bonds.
• A few ETFs and bond products concentrate on fallen angels.