A fallen angel is a bond that was initially investment grade but has been downgraded to junk status due to deteriorating credit quality.
A fallen angel refers to a bond or debt security that was originally issued with an investment-grade credit rating but has since been downgraded to below investment grade, commonly referred to as 'junk' status. This downgrade usually results from the issuer’s declining financial health or adverse changes in business conditions that increase the risk of default. Despite their poorer credit status, fallen angels may still have considerable value or potential for price recovery. In finance and wealth management, fallen angels are often tracked by fixed-income investors looking for opportunities to buy undervalued high-yield securities. Because these bonds transition from stable to higher risk, they can offer attractive yields compared to traditional investment-grade bonds but carry greater risk. Analysts and portfolio managers monitor ratings changes closely to gauge market sentiment and credit risk under changing circumstances.
Understanding fallen angels is essential in constructing fixed-income portfolios with deliberate risk-return tradeoffs. Owning fallen angels can enhance income yields and provide capital appreciation if the issuer’s credit quality improves over time. However, these securities require diligent credit risk assessment, as their downgrade implies higher default risk and increased price volatility. From a reporting and governance perspective, tracking fallen angels allows wealth managers and family offices to manage risk exposure, stress test portfolios, and ensure compliance with investment policies concerning credit ratings. Tax planning is also impacted, as trading in high-yield fallen angels can generate both interest income and capital gains or losses that require accurate tracking for tax efficiency.
Consider a corporate bond initially rated BBB (investment grade) that is downgraded to BB (junk status) due to the issuing company's deteriorating financial situation. The bond’s price might decline from $102 to $85, but its yield increases from 4% to 7%, attracting investors willing to accept additional risk for higher income. A family office buying this bond post-downgrade is investing in a fallen angel, hoping for credit recovery and price appreciation.
Junk Bond
Junk bonds are debt securities rated below investment grade, signifying higher risk and higher potential yield. Fallen angels are a subset of junk bonds, specifically those downgraded from investment-grade status.
What causes a bond to become a fallen angel?
A bond becomes a fallen angel when the issuer’s credit rating is downgraded from investment grade to below investment grade due to worsening financial conditions, increased debt, or adverse business developments.
Are fallen angels riskier than other junk bonds?
Fallen angels might have lower risk relative to original junk bonds because they were initially investment grade and may have stronger underlying business fundamentals, but they still carry higher default risk than investment-grade bonds.
How can fallen angels benefit a fixed-income portfolio?
Fallen angels offer higher yields and potential price recovery, which can enhance portfolio income and total return if the issuer improves creditworthiness, making them attractive for yield-focused investors willing to assume credit risk.
