Introduction
A fallen angel refers to a bond which was originally accorded an investment-grade rating but, has since been reduced to junk bond status due to the weakening financial condition of the issuing company. A fallen angel may also refer to a stock whose price has fallen substantially from its all-time highs.
Understanding Fallen Angel
Fallen angel bonds are debt securities including corporate, municipal, or sovereign debt which have been downgraded by a rating service such as Standard & Poor's, Fitch, or Moody's Investors Service.
The main reason for bond downgrades is a decline in revenues, which hampers the issuers capabilities of servicing debt. In the case where declining revenues are combined with expanding debt levels, the risk for a downgrade increases substantially.
Despite fallen angel including stocks whose price has fallen, there is a difference between fallen angel bonds and value stocks. Value stocks have the potential to recover from short-term challenges and securities that are headed straight toward losses.
Fallen angel securities are often attractive to contrarian investors who wish to capitalize on the potential for a recovery by the issuer from a temporary setback.
Further Into The Concept
The downgrade process usually starts with debt being placed on negative credit watch, which may require portfolio managers to sell positions, depending on fund-specific covenants. The downgrade to junk bond further drives the selling pressure especially from funds that are restricted to holding investment-grade debt exclusively.
Fallen angel bonds can also present value within the high-yield category but only when the issuer has a reasonable chance of recovering from the downgrade.
There may be situations where the fallen angel bond issuers may not be able to recover their losses or revive their business. For example, where the company is experiencing declining revenues due to the introduction of products in the market which are superior to theirs, their product may disappear altogether. For example, the progression from VCR tapes to DVDs to a streaming video caused the disappearance of VCR tapes altogether.
