Heightened volatility is driving investors to safe havens, making 2016 the year of the bond market. While long-term bonds are the undisputed winners, the high yield corner has drawn attention over the past three months on investors' drive for higher yields and a rebound in oil price.
In addition, high-yield spreads have tightened significantly from 8.64 on February 12 to 6.36 currently, as per the BofA Merrill Lynch US High Yield Option-Adjusted Spread, making junk bonds attractive. This suggests that investors are now demanding lower premium than comparable Treasury bonds to compensate for the risk.
However, the risk of default is on the rise, dampening the appeal for junk bonds. This is because the resumption of the slide in commodity prices and renewed global growth concerns are weighing on companies' profits and balance sheets yet again. As per Moody's Investors Service, global junk bond defaults will accelerate to 5% by the end of November, up from the previous forecast of 4.6% one month ago, and 3.8% in March. Fitch Ratings expects high yield bond defaults to climb to 6% this year from 4.5% last year and touch the highest level since 2000.
Given the heightened credit risk and low rate environment, investors thronged the high yield quality fund - VanEck Vectors Fallen Angel High Yield Bond ETF (NYSEARCA:ANGL). The fund gained 12.3% in the year-to-date time frame, outperforming the broad bond fund (NYSEARCA:BND) and junk bond fund (NYSEARCA:JNK) by wide margins.
ANGL in Focus
This ETF seeks to track the performance of the BofA Merrill Lynch US Fallen Angel High Yield Index, which focuses on the 'fallen angel' bonds. Fallen angel bonds are high yield securities that were once investment grade but have fallen from grace and are now trading as junk bonds. This unique approach gives the portfolio 248 securities that are widely spread across them, with none holding more than 1.65% of assets.
The fund has an effective duration of 5.67 years and year to maturity of 9.33. Additionally, the product mainly comprises of BB and B rated corporates, which together make up for 85.3% of the asset base. Bonds from energy and material sectors occupy the top two positions with 25.2% and 22.1%, respectively, while financial and communications round off the top four with double-digit allocation.
ANGL has amassed $158.7 million in its asset base while trades in moderate volume of 82,000 shares a day on average. It charges a relatively low fee of 40 bps per year from investors and yields 5.20% per annum.
Behind The Success of ANGL
The fallen angels strategy is immensely successful this year as the number of fallen angels has increased substantially on a series of debt downgrades among energy and material firms - the top two sectors of the ETF. In this regard, Moody's snatched investment grade ratings from 51 companies and gave them the junk status at the end of the first quarter, up from eight in the fourth quarter and 45 for the whole of 2015. These downgrades have boosted the performance of the ETF as bond price generally rebounds after losing an investment grade rating.
Additionally, the rebound in oil prices from the 12-year low reached in mid-February injects further strength into these bonds and the ETF.
As a result, fallen angels bonds tend to have lower default rates than their more traditional junk bond counterparts, thus offering better risk-reward profiles. These have a history of outperformance in nine out of the last 12 calendar years, according to Market Vectors. Moreover, the outperformance of ANGL was spurred by its higher average credit quality as about three-fourths of the portfolio carry the upper-end rating (BB) of the junk category, leaving just less than 4% to the risky CCC-rated and lower.
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