Search this website. You can use fund codes to locate specific funds

Weekly credit insight

Chart of the week: are fallen angels a blessing in disguise?

Fallen angel risk – or the possibility that bonds will be downgraded to junk status – has dominated the headlines over the past two years. And for good reason: the BBB-rated segment of the market (the lowest tier of investment grade) has grown from less than $2trn in 2010 to nearly $5.5trn in 2020 (see figure 1).

Figure 1. The size of the BBB-rated universe has soared over the past decade

Source: Federated Hermes, as at January 2020.

There are several reasons for this. Interest rates at record lows encouraged companies to increase their share of debt financing, while a stronger macroeconomic environment in the run-up to the summer of 2018 led to a growing number of rising stars.1 In addition, quantitative easing and the growth of reverse Yankees2 mean the European BBB-rated market has quadrupled to €1.2tn over the past decade.

The global high-yield market has also stagnated since 2015. Financing was redirected to the leveraged-loan market, which benefited from the recovery in collaterised-loan obligations and the move into floating-rate products by retail clients spooked by rising interest rates. This meant the US ten-year treasury yield rose from 1.35% in 2016 to 3.25% in 2018.

This year has seen a number of companies downgraded. While it seems that pressure is building up in certain parts of the market, the high-yield space has shrunk by more than $100bn over the past five years. With nearly all BB-rated bonds trading above call, these downgrades could be seen as a blessing rather than a curse.  

The risk of a recession is low, and the majority of companies are wary of forsaking their investment-grade ratings in exchange for higher shareholder returns. This means that there should be just enough fallen angels in 2020 to reinject some convexity into the BB-rated market and introduce more liquid capital structures with multiple access points.

Importantly, a pickup in fallen angels should also increase the size of the high-yield market – something that is greatly needed, given that macroeconomic uncertainty has lowered demand for equities and a silver-tsunami reallocation to fixed income is well underway.

More Insights

Authenticity in ESG integration
We explain why the delivery of Sustainable Wealth Creation has and always will be our core purpose.
Global Equity ESG: Annual Report 2020
Combining attractive fundamentals and good or improving ESG characteristics
Weekly Credit Insight
Dispersion in year-to-date returns across various parts of the global credit universe.
Zen and the art of investment management
Exploring mindfulness as a vehicle for truly responsible investing
Fiorino: bond themes and late-cycle mood music: as rates go up-tempo, markets rotate
As global economies emerge from the Covid-19 doldrums, bond markets could be tiring. But late-stage fixed income dynamics can also play out well for astute investors. Fiorino conducts a brief enquiry.
Stewardship during a crisis: Lessons from the pandemic
Dr Hans-Christoph Hirt, Head of EOS, reflects on the pandemic and the stewardship lessons for companies and investors.