Fallen Angels - A Neglected Segment of the High Yield Market: Hotchkis & Wiley Q4
The high yield market can be segmented in a multitude of ways — credit rating, sector, and seniority to name a few. The market can also be split into original high yield issues and fallen angel . Original high yield issues are credits that were high yield rated when issued (BB+ or below), and fallen angels are credits that were investment grade rated when issued (BBB - or above) , but have since been downgraded. The two market segments often exhibit considerably dif ferent characteristics and behaviors. We believe fallen angels represent an often-overlooked segment of the market that habitually offers compel ling risk/reward opportunities, particularly for bottom - up credit pickers.
This newsletter will first compare current and historical characteristics of fallen angels and original high yield issues. Next, we will evaluate how fallen angels have performed relative to the rest of the high yield market. Finally, we will explore how fallen angels recover (or fail to recover) and highlight keys to investing in this high yield market niche effectively.
I. Characteristics of the Fallen Angel Market
The term "fallen angel" represents a former investment grade credit (BBB - rated or above) that has been downgraded to high yield (BB - rated or below) by one or more of the major rating agencies. Rating agencies will downgrade a bond when it perceive s increased risks regarding the bond issuer 's ability to make its principal and/or interest payments. The perceived increase in risk can be due to company - specific factors, industry factors, cyclical factors, or a combination thereof. As of September 30, 2013, the total size of the high yield market was approximately $1.25 trillion 1. As shown in Chart 1, fallen angels comprised approximately 13% of the market, or $161 billion as of this date. Historically, fallen angels have represented between 8% and 30% of the market at any given time.
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