Investors are piling into the bonds that were most battered by the coronavirus pandemic as a vaccine-fueled recovery trade ripples across assets.
The iShares U.S. Fallen Angels USD Bond ETF (ticker FALN) -- which tracks U.S. corporate bonds that have lost the investment-grade status -- posted a record weekly inflow of $478 million, followed by another $93 million influx at the start of this week, according to data compiled by Bloomberg. That demand doubled the fund’s assets to more than $1 billion.
There were twice as many downgrades to American companies in 2020 than in 2019 due to the pandemic’s economic toll. However, with vaccines being rolled out globally, investors have been pouring cash into areas of the market that bore the brunt of last March’s hit. That has benefited junk bonds and so-called fallen angels, which experience mechanical selling after being booted from high-grade indexes, according to Peter Tchir of Academy Securities. While the rally has been “impressive” so far, there’s still room to go, he said.
“Buy anything with a Covid discount still built in -- that should dissipate over time,” said Tchir, the firm’s head of macro strategy. “The fallen angel can cause forced selling originally based on rating, and there was some real fear, so they had a lot of room to outperform.”
FALN has surged over 50% since the Federal Reserve announced its credit-market backstop in late March. The ETF’s biggest holding is a 2023 Carnival Corp. bond, thanks to a June downgrade from S&P Global Ratings, citing that the cruise line operator’s credit metrics were likely “to remain very weak through at least 2021.”
But now, after a flurry of vaccine breakthroughs in November, investors are going full-bore on the reflation trade. Small-cap stocks -- a laggard for most of 2020 -- have surged past broader market indexes, while breakeven inflation expectations climb to multi-year highs. That narrative, along with an ongoing hunt for yield, has boosted the appeal of recently downgraded debt, according to Wells Fargo Investment Institute.
“The whole script flipped in early November,” said Sameer Samana, senior global market strategist at the firm. “Investors are betting that a re-opening of the global economy, along with the reflationary trends that we’re seeing, will lead to spread tightening and credit rating upgrades.”
This article was provided by Bloomberg News.