A Unique Strategy to Prosper From Junk Bonds

Junk bonds appeal to investors who are willing to accept more risk in exchange for superior yields. But a subset of the high-yield universe—bonds that were issued with investment-grade ratings but have since descended to junk status—has delivered blissful results of late. Over the past five years, an index of these “fallen angel” bonds has returned an annualized 10.6%, crushing the broad U.S. bond market by an average of 6.5 percentage points per year and traditional junk bonds by 3.6 points per year.

A way to play formerly high-grade IOUs is Market Vectors Fallen Angel High Yield Bond ETF (symbol ANGL). The exchange-traded fund holds debt from 162 issuers. Nearly three-fourths of its assets are in bonds that occupy the highest rung of the junk ladder (those rated double-B), more than twice that of the typical high-yield bond ETF. “Weak balance sheets, poor management, a loss of market share or other troubles brought these fallen angels into the index,” says manager Fran Rodilosso. “But the companies still tend to have valuable assets.”

Thanks to the collapse of oil prices, several energy companies earned their wings as fallen angels this year. As a result, the fund’s stake in bonds issued by energy firms, such as Transocean and DCP Midstream Partners, has increased in recent months. Other top holdings include bonds of loan servicer Sallie Mae and aluminum maker Alcoa.

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