Fallen angels – Cover story
HOW HIGH CAN THEY FLY?
Does anyone fancy committing to a seven-year cruise ship journey? It might not sound the most appealing offer consider- ing the current climate, but for many fixed income investors it proved an attractive prospect. Indeed, cruise ship operator Carnival Cruises collected more than $6bn (£4.5bn) from issuing seven-year bonds back in April. Despite forecasting a “zero revenue scenario”, the offer was over-subscribed and is part of around $10bn (£7.6bn) that the cruise ship giant has raised this year to keep it afloat as bookings dried up. A double-digit coupon partially secured against the company’s fleet could explain the bonds’ appeal, but it also highlights the dramatic changes that the fixed income markets have seen this year. Even before the Covid pandemic arrived, bonds downgraded from investment grade to junk, known in the industry as fallen angels, were on investors’ radars. Madeleine King, Legal & General Investment Management’s co-head of pan-European investment-grade research, warned at the end of last year, that some $460bn (£369bn) of invest- ment-grade debt was at risk of being downgraded to junk, or high yield as it is increasingly becoming known. The widespread economic damage caused by the pandemic accelerated this trend exponentially. In 2020, a record $640bn (£484bn) worth of bonds have been downgraded from invest- ment grade, according to S&P Global Ratings. These included big name brands such as Heinz, Kraft, Marks & Spencer, Brit- ish Airways, Next, Virgin Money and ITV. By the middle of this year, roughly half of Europe’s and the US’ investment-grade bonds had a BBB rating, indicating the potential for further growth in the fallen angel universe. But the deterioration in credit quality has not necessarily caused such companies problems in raising capital, as Carni- val Cruises illustrates. While it appeared at the outbreak of the crisis that bond markets could dry up, central banks swiftly responded with an unprecedented wave of quantitative easing. A particular turning point was the Fed’s pledge in March to start purchasing high-yield bonds. Since June, the US central bank started buying large volumes of high-yield ETFs and increasingly debt from individual issuers.
As a result, even companies that no longer had an income stream or reported a sharp profit decline could borrow from the international debt markets. Corporates, excluding banks, have issued a record $2.1trn (£1.6trn) in bonds this year, which in the US has seen corporate debt rise to 90% of GDP, the Institute of International Finance says.
Headaches and opportunities
The surge in downgrades could cause headaches for investors, particularly insurers or those with an investment-grade man-
Issue 98 | November 2020 | portfolio institutional | 21
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