VanEck has launched a new fixed income ETF in Europe providing exposure to the US dollar market of so-called ‘fallen angel’ bonds.
Fallen angel bonds have historically outperformed the broader high yield bond market.
The VanEck US Fallen Angel High Yield Bond UCITS ETF has been listed on London Stock Exchange in US dollars (USFA LN) and pound sterling (ANGB LN) as well as on Deutsche Börse Xetra in euros (FAV GY).
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.
Fallen angel bonds have historically delivered superior returns compared to the broader high yield market. This outperformance has been attributed to characteristics such as a relatively higher credit rating (approximately 80% of fallen angels hold a BB rating compared to around 50% for the broader high yield market), lower default rates, and the fact that fallen angels tend to be bonds from larger, well-established businesses that are particularly focused on returning to investment grade in order to access cheaper borrowing.
Martijn Rozemuller, CEO at VanEck Europe, commented: “Many institutional investors are often forced by their investment mandate to sell bonds when they are downgraded below investment grade. Our strategy systematically buys these oversold and possibly undervalued bonds. Fallen angels have historically shown a higher likelihood of returning to investment grade status following a downgrade than the broad spectrum of high yield bonds. This offers upside potential that investors can participate in with our ETF.”
Methodology
The ETF tracks the ICE US Fallen Angel High Yield 10% Constrained Index which comprises US dollar-denominated corporate bonds rated below investment grade that were originally issued at investment grade.
Eligible bonds must have been issued in the US domestic market by US or non-US developed market issuers. They must also have a remaining maturity of at least one year and a minimum amount outstanding of $250 million.
The index employs a market capitalization weighting scheme while capping any single issuer at 10%.
As of 5 September, the index was exhibiting a yield-to-worst of 7.52% with an effective duration of 4.97 years.
Over three-quarters (75.5%) of the index weight was allocated to bonds rated BB with the next-largest credit bucket exposures being B (13.7%) and BBB (4.4%).
Notable sector exposures included consumer cyclicals (23.4%), technology (17.2%), energy (14.5%), financials (12.3%), and industrials (10.0%).
The ETF comes with an expense ratio of 0.35%. Income is accumulated within the portfolio.
The fund complements the $40m VanEck Global Fallen Angel High Yield Bond UCITS ETF (GFA LN) which provides broader exposure to fallen angel bonds denominated in US dollars, pound sterling, euros, and Canadian dollars.