Why are «fallen angels» needed in an investor’s portfolio

Bonds do not provide high yields, but they are very much needed in a portfolio to reduce risks. If you want to make more money and are willing to take the associated risks, you can add Fallen Angels corporate bonds to your portfolio. These are securities of companies whose ratings were recently downgraded to speculative. We will tell you why they are so good.

«Fallen angels» refers to the upper segment of dollar-denominated corporate bonds, whose credit rating has been downgraded from investment to speculative. This usually happens due to temporary difficulties — for example, business transformation, the implementation of certain risks or large additional capital investments. We are talking about securities of large companies such as Ford or Kraft Heinz Foods. Typically, their debts are of relatively high credit quality. Therefore, the risk on them does not change much, while the profitability is growing.

Fallen angel bonds are available to Russian investors via ETF

Access to interesting papers

Unqualified investors in Russia have access to a limited number of bond issues. Most of the bond market in foreign currency is closed to them. But even if this were not the case, it would still be difficult to repeat the composition of the fund on its own: large investments are needed to buy the bonds of large companies in developed countries by the piece. With the cost of one bond at 200 thousand US dollars, this requires a multi-million dollar investment.

In addition, investing in individual companies carries greater risks than buying a pre-packaged ETF.

Diversification

FXFA allows you to diversify the part of the portfolio that is invested in bonds. FXFA has over 100 bonds in its assets. Plus, dollar-denominated debt securities of foreign companies in developed markets help protect their investments from ruble devaluation.

Additional profitability

Many foreign pension funds and other large institutional investors cannot hold non-investment grade bonds in their portfolios — this is their tough investment policy. Therefore, when the rating of the company is downgraded to high yield, they are forced to sell these bonds, which leads to a decrease in their price. Private investors get the opportunity to buy securities at a lower price and sell them at a higher price when the maturity approaches or the rating rises again.

The credit risk premium (the so-called increased return) allows investors to earn more than

on government bonds or debt securities of companies with investment ratings.

Risks

Fallen Angels is not a risk-free investment. It is not necessary to form the entire bond portfolio only from FXFA — after all, such investments can quickly decrease in price during a crisis. In addition, the increased profitability of such a strategy arises precisely because the bonds “inside” do not have the highest rating. It is very difficult to make money on risk-free bonds now, during the period of extremely low rates.

It is also important to remember about the duration risk (the sensitivity of the bond price to changes in the US Federal Reserve’s interest rate). The higher the duration, the higher the risk of a price decline with an increase in the interest rate. You can find out the current duration in the information sheet.

Not an individual investment recommendation. Each investor should compose his portfolio taking into account his own goals, timing and risk profile.

From October 1, 2021, all unqualified investors who want to buy complex financial instruments will need to be tested with their broker. But since all FinEx ETFs are included in the quotation lists of the Moscow Exchange, you will not need to take a test to buy them.

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