Sometimes, it pays to dabble in something that’s just a little bad in the bond market.
Companies that were once investment-grade rated and have since plunged into junk territory are offering some of the best returns in U.S. credit markets. So-called fallen angel securities have gained about 8 percent in the past 12 months, and 3 percent in 2015 alone, according to Bank of America Merrill Lynch index data.
The securities beat the overall U.S. corporate-bond market by 2.4 percentage points in the last year. When broken out by ratings, fallen angels bested both investment-grade and high-yield notes.
Investors in search of a way to juice returns should pay attention: Barclays Plc analysts expect about $30 billion of bonds to join these ranks within the next 18 months. A growing number of energy companies are struggling to maintain their top grades after crude values declined 50 percent.
“Historically, the best buying opportunity for fallen angels has been at the time of downgrade and immediately thereafter, as investors reallocate risk and prices fall,” Wells Fargo & Co. analysts wrote in a Feb. 17 report.
Barclays named Transocean Ltd. as having “a high likelihood of being downgraded after its earnings report on Wednesday unless it presents plans to reduce its debt,” according to a Feb. 20 report. Other candidates include Weatherford International Plc, Nabors Industries Ltd., Canadian Oil Sands Ltd., and DCP Midstream LLC, according to Barclays analysts.
Crude prices have plunged 54 percent since last year’s peak of $107 a barrel, the result of the U.S. producing more oil at the same time that a slowing global economy curbs demand. Transocean, which provides offshore drilling services for energy companies, is facing falling demand for its equipment as producers cut spending.
“The oil sell-off drastically changed the fundamental picture” for energy companies, the Barclays analysts wrote. It “has pushed several large credits to the precipice of downgrade from investment-grade to high-yield.”
Pam Easton, a Transocean spokeswoman, declined to comment.
While fallen angels account for only 7 percent of the U.S. high-yield bond market currently, Wells Fargo analysts said the proportion may rise quickly. Ratings companies such as Standard & Poor’s and Moody’s Investors Service tend to lower the grades in specific industries in waves.
“We recommend high-yield investors begin to do credit analysis,” so they can get a head-start taking advantage of companies’ fall from grace, Wells Fargo analysts Winifred Cisar and Logan Miller wrote in the Feb. 17 report.
Losing top-tier rankings is a blow to corporations that face higher borrowing costs and a smaller pool of investors willing to buy their debt. But the trend may be a blessing for bond buyers ready to take advantage of their fall from grace.