Fallen-Angel ETF Goes Global Hunting Late-Cycle Downgrades

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(Bloomberg) -- One of the best-performing exchange-traded bond funds in the U.S., which hunts for corporate credits newly downgraded to junk, is shaking off its domestic focus and going global.

The VanEck Vectors Global Fallen Angel High Yield Bond UCITS ETF is scheduled to start trading Friday on the London Stock Exchange under the ticker GFA. It’s an expanded version of VanEck’s U.S.-listed fund targeting fallen angels, which over the past five years has returned 7.6 percent, making it the second-best performer among all U.S. fixed-income ETFs. Since its 2012 inception, it’s also handily beaten benchmark investment-grade and high-yield credit funds.

The theory behind fallen angels is that forced selling by portfolio managers creates a buying opportunity in the debt by pushing down the price to below its fundamental value. Unlike its American cousin, the global fund will hold not only U.S. dollar-denominated bonds, but also foreign currency debt, opening up its portfolio to issuers from emerging markets like Brazil and Russia.

“The idea here is taking the same angel concept, the same dynamic of technical sell-offs crossing into high yield from investment grade, to capture a much more diverse group of issuers,” said Fran Rodilosso, head of fixed income ETF portfolio management at VanEck.

‘Hotspots’

Fallen angels have been made rare by a decade of near-zero rates that have let companies stave off downgrades to junk. In the U.S. they represent the slimmest share of the high-yield bond market in 20 years; in Europe they’re at a 10-year low, according to a report by Axa Investment Managers.

But an outbreak of downgrades looms as the business cycle turns and corporate earnings flag. Axa strategists see pressure building in consumer, retail and media industries, “the next hotspots for downgrades.”

While U.S. issuers constitute around a quarter of the ETF’s holdings, Brazilian companies are the second most-heavily weighted at 19 percent, followed by Italian issuers at 10 percent, according to the firm’s website. Over 21 percent of the bonds held in its portfolio are denominated in euro, while pound issues are just over 5 percent.

Top individual holdings include bonds from Telecom Italia, Intesa Sanpaolo and Teva Pharmaceuticals, which was cut to junk by Moody’s Investors Service on Jan. 12.

While both the U.S. and global indexes are down since Jan. 1, the global version has taken less of a tumble, having fallen 0.2 percent versus minus 1.6 percent for the U.S. gauge.

It remains to be seen whether the global ETF will get the same traction as the U.S. fund, ticker ANGL, where assets have swelled to more than $1.1 billion. There are risks in global fallen angels that don’t show up in the U.S. fund -- namely, emerging market and currency exposure, said Rodilosso.

Also, with bond investors taking a long, hard look at duration, it’s worth noting that fallen angels tend to have longer terms than the typical five- to 10-year range of high-yield debt, according to Rodilosso. But for a passive fund that seeks to scoop up undervalued securities, perhaps the biggest danger is one endemic to all such vehicles.

“The risk with any sort of rules-based trading strategy is that too many people start doing it,” Jan Van Eck, the firm’s CEO, said in a Bloomberg TV interview.

©2018 Bloomberg L.P.

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