“Fallen Angels” refers to corporate bonds or other debt instruments that were initially issued with an investment-grade credit rating but have subsequently been downgraded to speculative grade, commonly known as “junk” status. This reclassification signifies a material deterioration in the issuer’s financial health or credit profile. The term’s purpose is to identify a specific segment of the debt market characterized by increased credit risk but potentially higher yield opportunities for investors.
Mechanism
The reclassification mechanism for “Fallen Angels” involves credit rating agencies systematically reviewing the issuer’s financial statements, industry outlook, operational performance, and debt servicing capacity. Upon determining that the issuer no longer meets investment-grade criteria, the agency issues a downgrade, triggering a forced sale by institutional investors whose mandates restrict holdings to investment-grade securities. This action can precipitate significant price volatility and liquidity shifts in the affected debt.
Methodology
The strategic approach to analyzing “Fallen Angels” often involves a deep credit research framework focused on identifying issuers with a plausible path to recovery, or those where the market has overreacted to the downgrade. This methodology seeks to capitalize on potential mispricings arising from forced selling pressures, assessing the issuer’s capacity for turnaround, asset quality, and management strength. Investors aim to acquire these bonds at discounted prices, anticipating a future upgrade or successful debt repayment, thus generating capital gains and higher income.
Survival bias distorts mean reversion models by systematically removing failing bonds, creating an artificially stable dataset that underestimates risk.
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