BNY Investment has launched a fallen angel bond fund in Hong Kong, the first of its kind in the territory available for retail investors.
The BNY Mellon Efficient US Fallen Angels Beta fund will be managed by Insight Investment, a $838bn asset manager, with $252bn in fixed income assets.
The fund invests in fallen angels, an asset class made up of former investment grade bonds that have been downgraded to sub-investment grade (BB+ or lower).
The strategy aims to “exploit market structural inefficiencies” and relative value mispricing opportunities when bonds are downgraded by credit rating agencies.
Paul Benson, head of systematic fixed income at Insight said: “The fund seeks to take advantage of the technical dislocation that occurs when bonds are downgraded from investment grade to sub-investment grade, which can cause passive and active investment grade investors to become ‘forced sellers’ of fallen angel bonds.”
“Opportunities are created during these periods of high downgrade activity because spreads often widen disproportionately during the month of the downgrade relative to peers and to fair value.”
He said that a weakening economic backdrop suggests “we may soon approach a sweet spot for fallen angels, with potential for $30bn to $50bn of new fallen angels over the next 12 months as the economy moderates”.
“The data is telling us that leverage is deteriorating, interest coverage ratios are deteriorating, profitability is declining,” Benson said at a media roundtable in Hong Kong discussing the strategy.
“We’re seeing a very consistent trend. This is going to manifest itself as a downgrade wave.”
His team believes the economy is nearing the end of a “benign” regime and into a more normalised period which may see potentially $50bn of new fallen angels enter the high yield bond universe.
He said: “Our data indicates that all of the balance sheet metrics have now migrated below the historical averages, where rating agencies are going to have to sit up and pay attention.”
His team found that for roughly $800bn of triple B minus rated bonds, $370bn of those bonds are on negative watch – the biggest number since 2009.
“When you start to see that higher level of numbers, it gets a little trickier for that demand to keep up,” he said. “The fallen angels universe represents this high quality portion of high yield, with a little bit of triple C exposure.”
“But it’s not what attracts us to the asset class. What attracts us to the asset class is the potential for these double B-like bonds, to recover nicely.”
One of the reasons for the Hong Kong fund launch is because there has been a very significant rise in demand in Asia from investors for products that generate income and de-risk away from equities, Benson added.
