Introduction
A fallen angel refers to a bond which was originally given an investment-grade rating but has since been reduced to junk bond status due to the deteriorating 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 reduces the issuer's ability to meet debt obligations. If the decline in revenues is coupled with rising debt levels, the risk of a downgrade increases sharply.
While fallen angels can also refer to stocks that have seen a significant price drop, 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 offer value within the high-yield category, but only if the issuer has a realistic chance of recovery. However, not all issuers manage to recover. In some cases, the decline may be irreversible, such as when a company suffers losses due to market shifts toward superior products. For instance, the transition from VCR tapes to DVDs and eventually to streaming video rendered VCR tapes obsolete.
