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INVESTING IN FALLEN ANGELS DURING COVID-19 By Philip Messow
The pandemic has caused market turbulence on an unprecedented scale. Yet there are strategies which have been able to generate added value for investors, such as investing in Fallen Angels. The term Fallen Angels refers to bonds of issuers whose creditworthiness has deteriorated and whose credit rating has thus been downgraded from investment grade to high yield. Downgrades can trigger massive overreactions by investors, especially in times of significant market tension and stress. As a consequence, such bonds may temporarily trade below their fundamental value. This overreaction can be systematically exploited within the framework of high yield products.
obliged to comply with regulatory requirements with regard to credit ratings, as well as ETFs tracking an investment grade index, are forced to sell such bonds. However, the high yield market, with a market capitalisation of €1.7 trillion as of 31 March 2020, is significantly smaller than the investment grade universe, with a market capitalisation of €10.2 trillion. Hence, sales pressure may drive the market price of a bond below its fundamental value.
The temporary undervaluation has turned Fallen Angels into an important segment of the high yield universe for systematic strategies.
SALES PRESSURE DUE TO DOWNGRADES Downgrades to high yield ratings occur more frequently during an economic downturn. For instance, our analysis
Photo: Archive Quoniam
The downgrade of a bond to the high yield universe often leads to forced selling: institutional investors that are
shows that there were on average only nine Fallen Angels per month during the period from January 2010 to February 2020, compared to 106 downgrades in March 2020 alone. This demonstrates that Fallen Angels are predominantly influenced by systematic risk factors. Idiosyncratic risks play a lesser role here. Yet during times of crisis, it’s especially difficult to find new buyers in the stressed high yield market. This is due to the fact that many investors’ capacity to assume risk is reduced significantly when they are faced with strong market turbulence. It’s fair to expect the extent of temporary undervaluation of Fallen Angels to be much larger during a crisis.
FOCUS ON ENERGY AND MANUFACTURING SECTOR
Dr. Philip Messow
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FINANCIAL INVESTIGATOR
NUMMER 8 / 2020
The present analysis looks at the performance of USD-denominated Fallen Angels for a period preceding the COVID19 crisis (January 2020 to February 2020) and during the first
