Fallen angels radar: positive 2024 supply dynamics

 

In this new quarterly publication, we monitor developments in the fallen-angels universe to find investment opportunities. Which corporate bond issues have lost their investment-grade (IG) rating to join the segment? How are corporate credit ratings progressing? What trends do we see emerging in credit quality?

 

 

Need to know New fallen-angels supply includes Walgreen Boots, Vornado Realty and Elia Group1 In 2024, we expect higher interest rates and lower disposable incomes to adversely impact credit metrics, leading to increased fallen-angels supply that could be a catalyst for performance Our active, bottom-up approach aims to find the most attractive entry points by investing in the bond when it has undergone the maximum price decline in response to the downgrade

 

Charting changes in the fallen-angels investable universe

Over the past quarter, the fallen-angels universe has seen a number of bonds being downgraded from investment grade to high yield (HY) and joining the fallen-angels index.² The graphic below chronicles progression in the universe, including new fallen angels and those moving deeper into high yield.

 

Source: LOIM. For illustrative purposes only. Credit ratings are subject to change. Important information on case studies: The case studies provided in this document are for illustrative purposes only and do not purport to be recommendation of an investment in, or a comprehensive statement of all of the factors or considerations which may be relevant to an investment in, the referenced securities. The case studies have been selected to illustrate the investment process undertaken by the Manager in respect of a certain type of investment, but may not be representative of the Fund's past or future portfolio of investments as a whole and it should be understood that the case studies of themselves will not be sufficient to give a clear and balanced view of the investment process undertaken by the Manager or of the composition of the investment portfolio of the Fund now or in the future.

 

What’s the outlook for fallen angels?

Going forward, we expect a moderation in rising stars, or bond issues elevated to investment grade. Essentially, expected upgrades of sub-IG companies have now occurred, such as Ford’s⁴ upgrade in October. Meanwhile, the continued higher interest-rate environment will adversely impact consumer demand – as lower disposable income prompts consumers to defer non-essential or big ticket purchases like holidays or cars – and increase companies’ financing costs, in turn pressuring financial metrics.

This dynamic means the universe is more likely to grow than shrink, in our view, supporting our fallen angels strategy, which invests in new names when they enter the index, usually at a price that is materially lower than similarly rated peers⁵ . The prices of fallen angels generally recover over a six-to-24 month period after the initial downgrade to high yield, which we believe should be supportive of performance going forward.  

By sector, we are cautious on companies relying on consumer discretionary spending, which we expect to be weaker in 2024 due to lower disposable incomes. We are, therefore, monitoring the automotive, hotel and leisure, and airline sectors carefully. Conversely, we are more constructive on the challenged real estate sector due to

• The apparent stabilisation of interest rates, albeit at relatively high levels compared to the recent past
• Improved investor sentiment
• Attractive yield potential

 

How can we optimise fallen-angel potential?

Our research shows the best time to invest in fallen angels is generally at the end of the month in which they are downgraded to high yield. Supply is ample because many investors are forced to sell their holdings as they leave the investment grade index. Demand is low, however, because high-yield investors are unfamiliar with the name or may have concerns about the sector. This creates attractive valuations.

We are always aware that fallen angels fall for a reason. It is vital that investors are satisfied that the company can stabilise its credit metrics and continue to operate as a BB rated entity rather than becoming a falling knife. As such, active management – incorporating fundamental analysis complemented by robust, ongoing performance monitoring of each fallen angel – is critical.

 

For professional investors only

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