The Centre for Asset Management Research
at Cass Business School, City, University of London in
cooperation with Invesco Powershares has launched the
latest in a series of white papers, "Fallen Angels: The investment
opportunity", which looks at the investment potential offered by
The corporate bond markets can be broadly categorised into two groups:
Investment Grade and High Yield.
Investment Grade bonds are those deemed to have been issused by governments
or corporations that are highly unlikely to default. High Yield bonds are
generally considered to come with a higher risk of issuer default, relative to
bonds issued by entities with investment grade ratings, although generally
there is the potential reward of a higher yield.
Some bonds however begin life as investment grade but due to a decline in
the perceived credit quality of the issuer, they may be downgraded to high
yield status. These bonds are referred to as fallen angels. This white paper
looks at the impact on bond prices of such a downgrade and why this phenomenon
could be of interest to investors.
The possible influence of the Overreaction Hypothesis is considered, in that
investors may react too strongly to news of a downgrade, resulting in a sharp
drop in price. This drop may subsequently be reversed if an overreaction has
been in evidence, wherein an opportunity for investment may lie. The paper also
considers institutional influences that may also compel investors to sell bonds
in the event of a rating downgrade.
The paper presents a study conducted by the authors in which the price
performance of 534 bonds was analysed. The periods for analysis were the 30
days before their downgrade and the first 30 days after. It finds that there is
a case for investing in fallen angels, with index investing being the most
accessible way into such an investment strategy. The paper concludes that price
rises seen in fallen angels, six to seven days after a downgrade, offer an
opportunity to enhance the returns on a multi-asset class portfolio, and the
potential to improve portfolio diversification.