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Corporate bonds known as “fallen angel bonds” were formerly classified as investment grade but were later lowered to junk or below investment grade status. This kind of bond could be a cross between high-yield and investment-grade bonds. To learn about what is a fallen angel bond, fallen angle bond example, read on.
Fallen angel bonds meaning.
A Fallen Angel Bond is an investment-grade corporate bond that was dropped from an investment-grade rating to a high-yield (non-investment grade) rating because of unfavorable conditions at the issuer after it was first issued.
Investors should consider the upgrade or downgrade risk when examining bonds. It is simple to predict when a bond will be raised or downgraded from its present rating; however, it is more challenging to forecast when a bond will fully recover to its initial investment-grade status.
Investors must comprehend what Fallen Angel means if they intend to purchase these kinds of bonds. Before making any judgments about their current holdings, individuals should study the factors that impact an upgrade or downgrade of a bond if they have fallen angel bonds in their portfolio.
Investments in fallen angel bonds include a high level of risk, and profits are not always sure. Before purchasing these assets, you, as an investor, must make an informed choice based on your financial status, risk tolerance, and other considerations. The fact that fallen angel bonds are regarded as lesser quality assets than those issued by businesses with consistent revenue streams should also warn investors that there is no assurance that they will ever recoup their stated value.
Put another way, because they don’t have the same resources to cover the debt if something goes wrong, fallen angels are riskier than conventional high-yield debt products like junk bonds or convertible notes. However, suppose enough new investors join in during bankruptcy proceedings or after a successful liquidation. In that case, they may still be able to make a partial recovery or even finish their payment schedule.
Distinct characteristics of fallen angel bonds
Despite their similarities with investment grade bonds, fallen angel bonds have some unique features that differentiate them from other types of bonds:
- Downgraded Credit Ratings: The main characteristic of a fallen angel bond funds is its downgraded credit rating. This indicates a higher risk of default compared to investment-grade bonds.
- Higher Yields: Due to the increased fallen angel bond risk they typically offer higher yields or interest rates than investment-grade bonds.
- Potential for Upgrade: While high-yield bonds are unlikely to be upgraded to investment grade, fallen angel bonds have the potential to regain their investment grade status. This makes them attractive for investors looking for higher yields and potential credit rating improvements.
Advantages of investing in fallen angel bonds
- Higher Yields: As mentioned earlier, fallen angel bonds typically offer higher yields than investment-grade bonds due to their downgraded credit ratings. This can be attractive for investors looking to earn a higher investment return.
- Potential for Credit Rating Improvement: Fallen angel bonds have the potential to regain their investment grade status if the company’s financial situation improves. This can lead to increased bond prices and potentially higher returns for investors.
- Diversification: Investing in fallen angel bonds can provide diversification to a portfolio. As these bonds have different risk profiles compared to other types of bonds, they can help balance out the risk in a portfolio.
- Lower Risk Compared to High-Yield Bonds: Although fallen angel bonds have a higher risk than investment-grade bonds, they are still considered less risky than high-yield bonds. This can make them an attractive option for investors who want to earn higher yields without taking on too much risk.
- Potential for Capital Appreciation: Along with the potential for credit rating improvement, fallen angel bonds also have the possibility of capital appreciation if their prices increase. This can result in high returns for investors who hold onto these bonds.
Drawbacks of Fallen Angel Bonds
- Higher Risk Compared to Investment-Grade Bonds: Despite being less risky than high-yield bonds, fallen angel bonds still have a higher risk than investment-grade bonds. This means there is a greater chance of default and potential investment loss.
- Credit Rating Downgrades: As fallen angel bonds have already been downgraded from investment grade, there is always a risk of further credit rating downgrades if the company’s financial situation worsens. This can result in lower bond prices and potentially significant losses for investors.
- Higher Volatility: Due to their lower credit ratings and potential for credit rating changes, fallen angel bonds can be more volatile than investment-grade bonds. This means their prices may fluctuate more, making them riskier for investors.
- Limited Supply: Fallen angel bonds are less common than other corporate bonds, and there may be limited supply in the market. This can make it difficult for investors to find suitable investment options.
- Lack of Liquidity: As fallen angel bonds are less liquid than other types of bonds, there may be challenges in buying and selling them in the market. This can make it difficult for investors to exit their positions if needed or result in higher transaction costs.
The difference between a fallen angel and a rising star bonds
| Aspect | Fallen Angel Bonds | Rising Star Bonds |
| Credit Rating | Initially, it had investment-grade ratings but was downgraded to junk due to financial difficulties. | Initially rated as high-yield or junk bonds, but expected to improve to investment-grade status due to improving financial conditions. |
| Risk Profile | Higher risk due to financial instability and potential for further downgrades. | Moderate risk as companies are on the path to recovery but still carry some uncertainty. |
| Yield | Generally deliver higher yields compared to investment-grade bonds to compensate for higher risk. | Offer slightly lower yields compared to fallen angel bonds due to lower risk. |
| Price Volatility | Can experience higher price volatility due to changes in credit quality and market sentiment. | Generally exhibit lower price volatility than fallen angel bonds as they are perceived as less risky. |
| Investor Preference | Attract investors seeking higher yields and willing to take on higher risk. | Attract investors looking for potential capital appreciation as credit quality improves. |
The Bottom Line
Fallen angel bonds are a unique type of corporate bond that can offer higher yields and potential credit rating improvements. However, they also come with increased risk and volatility compared to investment-grade bonds. As with any investment, it is essential to carefully consider all factors before investing in fallen angel bonds to determine if they align with your financial goals and risk tolerance. So, conducting thorough research and consulting with a professional financial advisor before making investment decisions is vital.
FAQs
A fallen angel bond is a corporate bond that was initially issued with an investment grade rating but has since been downgraded to below investment grade or junk status.
The main advantage of investing in fallen angel bonds is the potential for higher yields and the possibility of credit rating improvement.
Investors should carefully consider their risk tolerance and financial goals before investing in fallen angel bonds and conduct deep research or consult a financial advisor.
Fallen angel bonds share similarities with investment grade and high-yield bonds but have distinct characteristics such as their downgraded credit rating and potential for upgrade.
Fallen angel bonds are typically issued by companies that were once financially stable and had a good credit rating but have since faced financial difficulties.