Yields at 8% while Rising Stars Outpace Fallen Angels

This is what you need to know about U.S. Fallen Angels from the third quarter of 2023.

In regards to performance, the fallen angels continue to underperform broad high yield and there's been multiple rallies in lower quality bonds which have lower representation in the fallen angel universe. This means that triple-C rated bonds have been outperforming double-B rated bonds.

The other reason why this has happened is the overall increase in yields. Overall, the underperformance of fallen angels to broad high yield in Q3 was 92bps. Year to date, fallen angels are underperforming by 151bps now. September was mostly a duration play, as the change in rates explained more than 100% of the difference in returns.

We have to make a note here and mention that fallen angels have a longer duration than the broad high yield market, which is reflective of the longer maturities usually found in the investment grade space.

If you look at the chart right now, you will see that long duration has been taking a hit. For example, the 10-year in March was around 350, and it has increased to about 460 by the end of September.

Overall the year, duration has been playing a key role. However, there's two good things about fallen angels right now. One, when you compare them to Broad High Yield, sector exposures and selection within those sectors, meaning bonds within the sectors, have been positive contributors to relative performance year to date.

The story of the year is that rising stars continue to outpace fallen angels. If you look at the fallen angel index market value, it has seen a decrease of about 35-40% due to rising stars and an increase of about 14% of new fallen angels. This is very different to what happened in 2022 when there were only 18% of rising stars exiting the index versus 8% of new fallen angels.

This year, the largest rising star was Occidental Petroleum at about 9% weight that exited back in May, while the largest fallen angel was Brandywine Operating Partnership, which only added about 2% and it entered the index in September of this year. Brandywine is the first office REIT of the year, but given the ongoing pressures on the commercial real estate sector, due to tighter financial condition, and the stress on the regional banking sector, it will be interesting to see if more rates are downgraded by the indices in the coming months.

Looking forward, JP Morgan has estimated that 2024, there will be about 39 to 40 billion of rising stars versus about 29 to 30 billion of fallen angels, meaning that the story of 2022 and 2023, will probably be the same in 2024.

Something to keep an eye on, and you'll see it on the table, is that on 2023, they still have a rising star there. And over the coming months, S&P is expected to review for rating. And most analysts are expecting to see an upgrade from high yield into investment grade.

Fallen angel yields are back above 8%. Yield increased by about 60bps in September, and they're currently 8.02%. It's the highest yield it's been since March 2020 or during COVID. And prior to that, it's only been surpassed by a couple of instances. If you look at the chart, global financial crisis yields spiked to about 25%. And only after that, in early 2016, you'll see the yield above 8.2%. This was when the price of oil declined due to concerns around China's economic growth.

However, spreads remain very tight despite widening over the last few weeks of September and into early October. This is something we're keeping an eye out for the remainder of the year to see how spreads on yield react. And we will see you again next month.