The $190 million Invesco US High Yield Fallen Angels UCITS ETF has adjusted its investment approach following a revision of the underlying index methodology.

Fallen angel bonds significantly outperformed the broader high yield corporate bond market following the economic fallout from Covid-19.

The fund is linked to the FTSE Time-Weighted US Fallen Angel Bond Select Index which consists of USD-denominated ‘fallen angel’ bonds of issuers domiciled in North America.

Fallen angels are bonds that were originally issued with investment grade status but have since been downgraded to junk.

The strategy of investing in fallen angels is based on the premise that the overly negative sentiment surrounding a downgrade into junk territory causes fallen angel bonds to be regularly oversold as investors, often forced by their investment mandate, sell en masse prior to and at downgrade, leading to a price anomaly.

The strategy last showed its merits in 2020 following the economic fallout caused by Covid-19. That year saw the number of new fallen angels increase at the fastest rate since the financial crisis, while the total value of new fallen angel debt reached a massive $165 billion. Invesco’s fallen angels ETF outperformed the broader high yield corporate bond market (as referenced by the iShares $ High Yield Corp Bond UCITS ETF) by 4.24% in 2020 (8.98% vs. 4.74%).

Timing is a critical factor when investing in fallen angels. In a bid to better capture the strategy’s technical element, the index underlying Invesco’s fallen angels ETF is time-weighted, allocating higher weights to those bonds that have been downgraded most recently in an attempt to maximize the return from any ‘V-shaped’ bounce the downgraded bonds may exhibit.

Any bond entering the index is given a predefined time score and, starting from the 13th month upon entering the index, that score is gradually reduced. On each monthly rebalance, the time scores for all bonds in the index are normalized to weights, subject to individual issuer caps, that sum up to 100%.

Effective 1 February, the index has now undergone three notable changes.

The first two changes involve boosting the minimum issue size from $250m to $300m and increasing the minimum credit rating from C to B-. These measures are designed to boost the liquidity profile of the index while also avoiding issuers in dire financial distress that are most likely to default rather than make a recovery.

The third methodology alteration involves lowering the time-based weight cap for issuers from five times to three times their respective market value-based weights. This measure is aimed at enhancing the index’s diversification and spreading risk away from the largest constituents. Any issuer in the index will still also be subject to an absolute cap of 5%.

The strategy may appeal to income-hunting investors who are willing to accept a level of risk that is slightly below the broader high yield corporate bond market. As of the end of December, the index was yielding 7.84% with an effective duration of 5.25 years. The vast majority of the index was allocated to bonds rated BB (87.4% vs. 69.8% for the broader high yield corporate bond market) and B (6.3% vs. 22.3%)

The ETF comes with an expense ratio of 0.45% and is available to trade on London Stock Exchange in US dollars (HYFA LN) and pound sterling (FAHY LN), on SIX Swiss Exchange in US dollars (HYFA SW), and on Xetra (FAHY GY), Euronext Paris (HYFA FP), and Euronext Milan (HYFA IM) in euros.