Fallen angels – Roundtable

printed by governments and it has to be parked somewhere. Every sector of the market will have a reasonable amount of liquidity.

PI: What impact has central bank stimulus had on fallen angels? Trow: Rates are low and the economic out- look uncertain, so people have kept their funding requirements to a minimum. There is not as much supply out there as you would hope.

Investors have been trying to find pockets of liquidity while issuers have kept their heads down. If they are issuing, they are doing it in tandem with tender offers or pre-funding several months or years hence. What we are beginning to see in the whole credit market is that we have cannibalised potential issuance for the next year or two. We might be in a situation where fallen angel strategies are ideal because people are scrapping around for anything to buy with a bit of spread. Hollis: Central bank buying has not done very much to tighten high yield spreads because they did not buy very much high yield debt. It did a lot for confidence but little in terms of dollar and cents for the overall market. But the Fed’s announce- ment was a huge game changer for senti- ment on credit, especially fallen angels, as they said recently downgraded issues, including Ford, were eligible for Fed buying.

That was announced when the market was in panic mode and fallen angels were being sold off left, right and centre. On the day of that announcement the sell off stopped, went into reverse and fallen angels outperformed bonds that were originally issued as high yield by a signif- icant amount. Hayes: The Fed needed to step in and sta- bilise the entire risk market spectrum, including equities. Liquidity had almost evaporated, markets were dislocated and companies could not issue debt. The Fed coming in provided a floor. Although it

did not buy much in dollar terms, it showed the market that central banks are willing to step in when needed. The Fed officially stopped buying corpo- rate debt at the end of December. Is that a risk or a concern? No. We have seen its willingness. If the markets go back into disarray, in the markets’ mind there is a backstop in that central banks will step in and provide stability. Kwatra: The narrowing of investment grade spreads is intensifying the search for yield. In our world, it is intensifying the search for private credit and illiquids across the investment grade spectrum. Visavadia: Most pension schemes are positioned to take advantage of fallen angels through their credit portfolios. To get the yield, they invest in sub-invest- ment grade. Some of my managers look at deep value, distressed debt and high yield. I am sure these funds will take advantage of investing in fallen angels in the next 12 to 15 months.

PI: What do you expect to see in the fallen angel market during the next 12 months? Hayes: We are optimistic. The large BBB- bloat and $900bn (£648bn) of debt out- standing are levels we have never seen before. On the fundamental side, leverage is at an all-time high.

Combine these issues and concerns with the pandemic and it causes uncertainty, which excites me. From a cynical side of things, I am looking forward to every downgrade. If someone is willing to force sell investment grade bonds at huge dis- counts, I will be happy to take the other side of that. Kwatra: We are cautious on BBB invest- ments, by virtue

of penal capital

requirements as mentioned earlier. There is an expectation of certain sec- tors

continuing on a downward

trajectory, but we are also seeing signs of recovery. We navigate by sticking to the safer, less cyclical sectors, so the bonds moving into riskier territory are the ones we are not focused on. Trow: I am positive, with a caveat that we do not see a risk sell off. Fallen angels are interesting in the context of a risk rally, but what concerns me is that people are pressing for longer tenors, especially if you invest on a yield basis where you will get killed if benchmark yields turn quickly. With downgrades not necessarily filtering through to defaults, it

is an attractive

We are excited about the volatility.

Manuel Hayes, Mellon

space, but that is in an-all-things-being- equal scenario. Hollis: At the end of a long risk rally, when there have been a few fallen angels, several rising stars and a lot of maturities, you could have a fallen angel strategy that is concentrated by name and sector. At that point, you need to ask if those assets still do the job you want them to. Visavadia: If there is a recognition by asset managers that there is a dislocation between investment grade debt and fallen angels, they will do something about it. They will get better quality research, which could benefit investors at the end of the day. Weeks: The two groups trustees will be interested in are one, the regulators, and how they will see the market, and two, the specialists, especially if we have enough of them, or not, to navigate this newish sector, will be high in their minds.

Issue 102 | April 2021 | portfolio institutional | 47

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