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Weekly Credit Insight

Chart of the week: oiling the wheels of fallen angels

About $170bn-worth of fallen angels1 – or companies downgraded from investment-grade status – will be incorporated into high-yield indices at the end of this month, following the decision not to rebalance benchmarks in March.2

This will be the largest-ever monthly increase in absolute terms, but in line with the additions seen in 2011 and 2015 when accounting for the fact that it includes two months. Looking at the change from a relative perspective, the index will increase by 8% on the month before. This is higher than in previous years, but well below the magnitude suggested by the absolute figure and also beneath the 17% jump recorded in the early 2000s (see figure 1).

Figure 1. Monthly change in the size of the global high-yield index

Source: ICE Bond Indices, as at April 2020.

To some extent, this is a welcome change. The size of the high-yield index has stayed at about $2trn in recent years, while the investment-grade universe has grown by 30% (in part due to the increase in the BBB-rated segment of the market). The surge in fallen angels will also bolster the average credit quality of the high-yield index, which already stands at BB-.

How will fallen angels behave in this environment? We have analysed how the global high-yield market has performed both with and without the fallen angels that were excluded from the March rebalancing. The index that includes these fallen angels has delivered 4.2% over April, compared to 4.1% for the current high-yield market.

A large share of this outperformance has taken place since 9 April, when the Federal Reserve (Fed) announced that it would support fallen angels. If the European Central Bank (ECB) follows the Fed, the market could receive another boost – particularly given that the ECB is buying bonds with maturities up to 31 years, while the Fed is only focusing on the front end of the curve.

The oil-price crash is one explanation for the rise in fallen angels and the recent move lower will provide further impetus for investment-grade issuers to optimise their capital-allocation policies. The changing composition of the high-yield energy sector – or the fact that there will be a greater number of higher-rated companies – will undoubtedly put pressure on the lower end of the high-yield universe.

Investors throughout the world have been scrutinising fallen angels over the past month. Looking ahead, they will be closely monitoring the potential opportunities that this influx might present.

  1. 1As of 21 April 2020
  2. 2ICE bond indices is one example

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