The Fallen Angels Paradox: High Yield Bonds

Global Thought Leadership
2 July, 2020

2020 has already had the greatest number of downgrades to below-investment-grade on record, surpassing the annual amounts of the recession in 2002, the great financial crisis in 2009 and the commodity crash in 2015. Yet Western Asset sees the potential for opportunity amid the downgrades, if managed with care.

The economic damage from COVID-19 has taken its toll on the financial health of issuers in many sectors, both expected and otherwise.  Rating agencies have responded accordingly, according to Western Asset. One example: Moody’s has announced over 600 downgrades in the three months ended June 24, 2020, compared to the monthly average of 40 in the past two years.  As of the latter part of June, there were $973 billion of investment-grade (IG) corporates that are rated low BBB (BAA3 or BBB-). Of that amount, $466 billion is on a negative watch of at least one major rating agency.

As noted by Western Asset’s Thomas V. McMahon, that’s created an abundance of “fallen angels” without recent precedent:

“ To put this year’s fallen angel totals into historical perspective, 2020 has already had the greatest number of downgrades to below-investment-grade on record, surpassing the annual amounts of the recession in 2002, the great financial crisis in 2009 and the commodity crash in 2015. With $466 billion of BBB- issuers on negative watchlist, fallen angel volume will continue to increase throughout the balance of 2020. Wall Street strategist estimates for 2020 full-year fallen angel volume vary, ranging from $200 billion to $500 billion.”

(Excerpted from Fallen Angels Bring Opportunities )

Fallen Angels vs. Rising Stars

Source: J.P. Morgan, as of 29 May 2020. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The flock of fallen angels landing on the Bloomberg Barclays High Yield Indexes was paradoxically positive, leading the indexes generally higher:

“While the investment-grade indexes absorbed a lot of fallen angel pain, they’ve had quite the opposite impact since joining high-yield indexes.”

The shift, which Western Asset believes is far from ended, has made the ability of investment managers to analyze the longer-term financial health of fallen angels even more important than in more orderly markets, to potentially add to return or avoid unexpected losses.


 Definitions

COVID-19 is the World Health Organization's official designation of the current novel coronavirus disease. The virus causing the novel coronavirus disease is known as SARS­CoV-2.

A fallen angel is a bond that was rated investment-grade but has since been downgraded to junk status due to the declining financial position of its issuer. The bond is downgraded by one or more of the big three rating services.

A rising star is a business or a company that is relatively new to the debt capital markets, with little or no history of debt repayment. However, because of a low credit rating, the company's bonds are often considered high risk, therefore offering a premium yield.

A credit rating is a measure of an issuer’s ability to repay interest and principal in a timely manner. The credit ratings provided by Standard and Poor’s, Moody’s Investors Service and/or Fitch Ratings, Ltd. typically range from AAA (highest) to D (lowest). Please see www.standardandpoors.com, www.moodys.com, or www.fitchratings.com for details.

Moody’s Investors Service, Fitch Ratings and Standard & Poor’s Ratings Service are nationally recognized statistical rating organizations (NRSRO) in the business of assigning ratings to bonds as they are issued.

An investment-grade (IG) rating (AAA, AA, A, BBB for example) is one that indicates that a municipal or corporate bond has a relatively low risk of default. Bonds with below investment-grade ratings (BB, B, CCC for example) are considered low credit quality and have a higher risk of default.

 

  • Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

    Important Information 

    All investments involve risk, including possible loss of principal.

    The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

    Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

    International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

    Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

    Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

    Important Information:

    The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

    The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

    This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.

    This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

    All investors and eligible counterparties in EU and EEA countries:

    In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6, Building Three, Number One, Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4. D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

    In the UK, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the UK Financial Conduct Authority.

    In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  

    Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

    All Investors in Hong Kong and Singapore:

    This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

    This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

    All Investors in the People’s Republic of China (“PRC”):

    This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

    This material has not been reviewed by any regulatory authority in the PRC.

    Distributors and existing investors in Korea and Distributors in Taiwan:

    This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

    This material has not been reviewed by any regulatory authority in Korea or Taiwan.

    All Investors in the Americas:

    This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

    All Investors in Australia and New Zealand:

    This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.