The rising stars in today’s market

Fixed income is littered with concepts that are often hard to grasp. The same can not be said about Rising Stars and Fallen Angels. It’s not a fairy tale, but rather a method of classifying bonds. A Rising Star is a bond that is rated as a junk bond but could become investment grade. Conversely, a Fallen Angel, as the name suggests, is an investment-grade bond that has fallen to junk status. We believe that as rising star volume gains momentum throughout the global recovery, investors will be met with attractive return opportunities.

Over the course of 2020, as the COVID-19 pandemic adversely impacted fundamentals and markets, we experienced a new record US$184 billion in Fallen Angels, which migrated from Investment Grade into High Yield. Consistent with past cycles, these issuers presented attractive investment opportunities for High Yield investors to purchase high-quality businesses at a discount. During the first half of 2020, we leveraged our global fixed income platform to quickly add many of these Fallen Angels at discounts, benefitting our investors.

A fast-recovering global economy has driven a material shift in this dynamic, with last year’s Fallen Angels giving way to next year’s Rising Stars (names upgraded from High Yield into Investment Grade). Ratings agencies have upgraded High Yield credits at a 4:1 ratio thus far in 2021, and we have seen US$14 billion in Rising Star volume year-to-date. We believe this is just the beginning of a new trend, with Rising Star candidates over the next two years at approximately US$250 billion based on our bottom-up research views across Global Fixed Income research teams. This represents roughly 15% of the High Yield market and will likely be a material driver of returns in the years ahead.

To put some numbers around the investment opportunity, Rising Stars typically experience 75 – 100 basis points of spread tightening as they migrate toward full Investment Grade ratings. However, between 50% and 75% of this spread tightening generally takes place during the six- to 12-month period prior to receiving upgrades with the balance achieved concurrent with the actions themselves. There is a clear benefit to being on the earlier side of these trades.

While the Rising Star cohort carries approximately 50 basis points less yield when compared to the BB-index, it does still offer a 100bps yield pick-up relative to BBBs. Given this relative yield positioning and potential for credit improvement and related spread-tightening, we believe Rising Stars will offer an attractive investment opportunity within Global Fixed Income in the years ahead.

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