Fallen angel ETFs hit $10 billion in assets

Investors rushing to bet on a revival in pandemic-hit companies are driving unprecedented demand for ETFs that track beaten-down bonds.

With the economic reopening boosting corporate earnings in cyclical sectors, assets in U.S. exchange-traded funds buying so-called fallen angels — debt recently stripped of investment-grade status — have doubled in 2021 and just hit $10 billion, according to data compiled by Bloomberg.

The two major products, the iShares U.S. Fallen Angels USD Bond ETF (ticker FALN) and the VanEck Fallen Angel High Yield Bond ETF (ANGL), are on track for a historic 2021 with inflows of $4.3 billion and $1 billion, respectively.

The funds have been popular for a while after a wave of downgrades at the height of the COVID-19 crash. But with U.S. companies weathering the supply-side crisis, both look poised to benefit from continued economic growth. And it helps that they're less sensitive than other popular bond funds to interest-rate risk.

"In an environment of higher inflation and potentially higher rates, the fallen angels should fare quite well," said Peter Chatwell, head of multiasset strategy, Mizuho International. "They are predominantly in cyclical sectors and they have also been through quite significant deleveraging programs already."

The bonds of newly downgraded companies are typically oversold before recovering — the basis of the fallen-angel trade. Thanks to pandemic stimulus and fading lockdowns, investors are still piling in 18 months after corporate debt was battered in the COVID-19 rout.

By scooping up newly relegated securities and riding the rebound, FALN and ANGL have outperformed virtually every category of bonds this year, from inflation-protected securities to high-yield debt. Given that the funds are largely made up of economically sensitive sectors, the outperformance should continue, according to Mizuho.

Energy and telecom companies make up the bulk of holdings in FALN and ANGL.

The two funds have returned 5.6% and 6.7%, respectively, in 2021 so far. That compares with a loss of 5.5% for the iShares 20+ Year Treasury Bond ETF (TLT) and a loss of 1.2% for the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD). The SPDR Bloomberg High Yield Bond ETF (JNK) has returned 3.2%.

The fallen angel ETFs are likely also benefiting from a rotation away from products more vulnerable to rising yields and price pressures like LQD or TLT, Mr. Chatwell said. Both of those funds have relatively high duration — a measure of sensitivity to interest-rate changes — and have posted two straight months of outflows, according to Bloomberg data.

TLT and LQD have durations of about 19 years and 10 years, respectively, according to Bloomberg data. For FALN and ANGL, it is roughly seven years.