What is a Fallen Angel in Finance – Get All the Information
Have you ever wondered what a fallen angel in finance is and why it is crucial to understand it in the real estate industry? Why are fallen angels so popular in the bond market nowadays, and how to understand them the best?
In investing, the fallen angel refers to a bond primarily inherited with a high-quality rating. Nonetheless, it’s been lowered to the speculative-grade rating. The downgrade is usually referred to as a result of the issuer’s financial condition deteriorating.
To help you understand these bonds and their functioning the best, let’s get a closer look at the definition and explanation of the fallen angel by an expert!
What is the definition of a fallen angel?
A fallen angel in finance refers to a specific type of bond lodged in addition to the investment-grade rating. Due to the issuer’s deteriorating financial condition, its bonds are reduced to junk, including municipal, corporate, or sovereign debt.
Its bonds offer higher returns but come with increased risk. The decline primarily stems from a sharp decrease in the issuer’s revenue, resulting in insufficient resources to repay investors. Issuers often accumulate more debt to settle existing debt, exacerbating the downgrade.
Understanding the bonds better
In other words, these angels represent investment-grade bonds that decline due to the issuer’s financial downgrade. High-risk investors seek high-yield fallen angel bonds despite increased risk.
Fallen Angels bonds can face further declines as investors anticipate downgrades. This compounded fall can lead to rate cuts and industry repercussions, affecting the overall economy.
For instance, Company ‘Y’ bonds were downgraded to junk bond status (CCC) due to economic shifts and mounting debt, making its bond a Fallen Angel. While fallen angels historically outperformed, investors should have caution. It is also crucial to have in-depth research to identify the best opportunities and manage risk effectively.
What are the main characteristics of the Fallen Angel?
Originally, Fallen angel bonds outperformed original high-yield bonds. In 2015, European fallen angels provided returns of approximately 6%, surpassing regular high-yield bonds at 3%. So, let’s get to know more about the distinct features of fallen angel bonds, shall we?
Here are the main diverse characteristics of these bonds that any investor should keep in mind:
- Fallen angel bonds represent susceptible to higher price volatility due to a notable shift in the firm’s status.
- Market loos after selling these bonds in large quantities before anticipated downgrades and index changes.
- Once downgrades, investors may rush to purchase these bonds for speculative purposes, especially if the firm’s fundamentals are strong, with hopes of recovery and high price returns.
- As of 2016, they comprise approximately 4% of the bonds market.
- Fossil Group and Symantec were on the verge of being classified as Junk Bonds.
What are the main risks and opportunities of these bonds?
Any investor needs to consider certain types of risks while dealing with them. Here are the risks that you need to keep in mind:
- Firm-specific or industry-related publishing is able to lead to fallen angel status.
- Stable macroeconomic conditions and robust fundamentals are essential.
- Inadequate timing of debt financing and failure to adapt to competition and technology can cause struggles.
- Inferior credit quality results in price declines and portfolio fluctuations.
On the other side, there are certain opportunities regarding these bonds, which are:
- Temporary downgrades enable opportunities for discounted purchases.
- Strong fundamentals can yield higher long-term returns.
It is also crucial to remember that investing in these bonds is true of understanding the market and assessing risks.
Selling Pressure Driven by Junk Status – Explained
The downgrade to junk status triggers selling pressure, especially from funds restricted to investment-grade debt. Fallen angel bonds can offer value in the high-yield category if the issuer is reasonably likely to recover from the factors that caused the downgrade.
What is the opportunity in Fallen Angel?
Investors seeking opportunities during a fire sale can consider fallen angel bond funds. For example, the famous VanEck Vectors Fallen Angel High-Yield Bond ETF is mainly focused on downgraded bonds, including those from:
- Sprint Capital Corp.
- Vodafone Group PLC
- Freeport McMoran.
Remember that another option represents the iShares Fallen Angels USD Bond ETF, specifically investing in dollar-denominated fallen angels. Investors analyzing fallen angel bonds should carefully assess the issuer’s credit rating to evaluate the credit risk associated with the investment in the short term.
What are the main pros and cons of an Angel Investor?
For those interested in what are the main pros and cons of angel investing should keep in mind that the main pros are:
- They are comfortable with the risk involved in small-business investments, unlike banks that impose borrowing restrictions. They are also able to make larger investments and intuitively recognize promising ideas and deals.
- Having the backing of angel investors would increase the likelihood of long-term business success, substantial growth, and higher returns. It is because they bring valuable expertise and guidance alongside funding.
On the other hand, the main cons of this type of investment are:
- Once partnering with an angel investor, individuals should expect their active involvement in decision-making and interest in utilising funds. It means relinquishing total control and being accountable for explaining your decisions to someone unfamiliar with your business.
- Be cautious of the attached strings when accepting capital from an angel investor since it involves giving away a portion of future earnings through equity. It may limit your profitability. Evaluate the terms carefully to ensure you succeed.
- Also, be extremely cautious when investing, as corporate bonds could involve a great risk of default and can lead to potential losses in your investment portfolio.
Fallen angels, bonds downgraded to junk status due to financial troubles, can present opportunities for investors seeking fixed-income investments with higher returns. However, a well-defined investment strategy and thorough analysis of the financial markets are crucial to navigate the risks associated with these bonds and make informed decisions.