Definition
“Fallen Angels” in finance refers to bonds that were initially given investment-grade ratings but have since been downgraded to junk status due to the deteriorating financial health of the issuer. This downgrade can occur when the issuer’s ability to meet its debt obligations becomes uncertain, often due to factors such as operational issues, market changes, or macroeconomic instability. Despite their lower rating, these bonds often have the potential for high returns, which can make them attractive to some investors.
Key Takeaways
- ‘Fallen Angels’ is a finance term referring to bonds that were initially given an investment-grade rating but were subsequently downgraded to junk status, due to the deteriorating financial position of the issuer.
- These bonds tend to carry higher risk compared to investment-grade bonds; however, they potentially offer higher yields to compensate for the increased risk. This makes them attractive to income-focused investors who are willing to accept the increased risk.
- While investing in such bonds, investors need to closely monitor the bond issuer’s financials and overall market conditions, as there is a risk of further downgrades which can negatively impact the bond’s price and lead to potential losses.
Importance
The finance term “Fallen Angels” is of critical importance as it refers to bonds that have fallen out of investment grade and into junk status due to the deteriorating financial standings of the issuer.
These bonds are closely watched by investors due to their potential for high return on investment.
If a company once had a good credit rating but has since downgraded, the bond’s yield likely increased to entice investors, promising them higher compensation for taking on more risk.
Therefore, some investors find fallen angels to be lucrative investments as these bonds could turn profitable if the issuer regains stable financial footing and the value of the bonds consequently rebounds.
Explanation
Fallen Angels, in the context of finance, primarily function as a risk indicator in the investment world. They serve as a signal for investors, financial analysts, and portfolio managers to evaluate investment decisions, based on the creditworthiness of the issuing entity. This notion comes from the fact that ‘fallen angels’ are often linked with increased volatility and potential financial distress for the issuers.
The term helps investment professionals assess the financial risks associated with an issuer, thereby assisting them in making informed decisions on whether to buy, sell, or hold a particular debt product. Secondly, fallen angels are also an important component in the junk bond market. When a bond is downgraded to a junk or non-investment grade by a credit ratings agency, it tends to sell at a greater yield due to its high risk.
As a result, these high-yield bonds can provide substantial returns for investors willing to take on this higher risk. As such, they make for a significant strategy for some investment portfolios that aim to balance risk with the potential for high returns. Thus, understanding and monitoring ‘fallen angels’ becomes crucial for those in the business of high-risk, high-yield investments.
Examples of Fallen Angels
Ford Motor Company: In 2005, Ford was rated as investment grade by the bond rating agencies. However, during the 2008-2009 financial crisis, the company faced a severe drop in sales and profitability which led to the downgrade of its bonds to ‘junk’ status, making it a ‘Fallen Angel’.
General Electric: In 2018, General Electric, once an admired blue-chip company, was downgraded to ‘junk’ status by Moody’s Investors Services. The downgrade was mainly due to concerns about the company’s power business and deteriorating financial performance.
Deutsche Bank: In 2019, Deutsche Bank’s long-term debt was downgraded to BB+ by Fitch Ratings, placing it into the ‘junk’ category. The downgrade reflected doubts about the bank’s restructuring plan and its ability to improve its profitability and stabilize its balance sheet.
Fallen Angels FAQ
What are Fallen Angels in finance?
Fallen Angels in finance refer to bonds that were initially given an investment-grade rating but have since been reduced to junk bond status due to the deteriorating financial position of the issuer. They can also refer to stocks that have fallen dramatically in value from their historical highs.
What causes a bond to become a Fallen Angel?
A bond becomes a fallen angel primarily due to the financial difficulties faced by the issuer. This can be because of a variety of factors including an increase in debt, reduction in revenue, or an unfavorable business environment. Downgrading to junk status happens when credit rating agencies believe that the issuer has a higher risk of defaulting on its debt obligations.
How do Fallen Angels impact the market?
Fallen Angels can influence the financial markets significantly. For fixed income investors, a downgrade can lead to a price decline of the bond in the secondary market. This is because the downgrade would increase the perceived risk of the bond, and therefore the yield required by potential buyers of the bond. Conversely, it might present opportunities for investors who hunt for bargains and have a higher risk tolerance.
What are the risks and opportunities with Fallen Angels?
The risks associated with fallen angels include the risk of further downgrades and, ultimately, the risk of default by the issuer. However, they also represent potential opportunities. Since fallen angels are often oversold, their bond prices can be lower than their intrinsic values which can lead to profitable chances for investors if the issuer does not default and manages to recover its financial position.
How can I invest in Fallen Angels?
Investing in Fallen Angels involves buying bonds that have been downgraded or stocks that have fallen dramatically in price. This strategy can be appropriate for investors with a high risk tolerance and a belief in the issuer’s ability to recover. It’s important to conduct a careful analysis of the issuer and the reasons for the downgrade before investing.
Related Entrepreneurship Terms
- High Yield Bonds
- Credit Ratings
- Investment Grade
- Corporate Bonds
- Default Risk
Sources for More Information
- Investopedia: A comprehensive financial education website that will likely have detailed definitions and explanations about the term ‘Fallen Angels’.
- Morningstar: An investment research firm that offers a broad spectrum of financial information including theories and terminologies like ‘Fallen Angels’.
- The Balance: A large-scale financial education website providing in-depth articles and guides about various financial concepts.
- Bloomberg: A global information and technology company providing financial news, data and analysis which might give real-world examples of ‘Fallen Angels’.
