The economic and market disruption in the spring brought bad news for many sectors, with particular impact on high-yield bonds, those issued by below-investment-grade companies who are typically at higher risk of default. So-called “junk” bonds predictably struggled as the market fell, with major high-yield bond funds plunging by 20% or more from peak to trough. The effective yields on those instruments exploded, roughly doubling from a level of 5.5% to nearly 11%, marking their highest levels since the financial crisis of 2008-09.

As the market has recovered, concerns about high-yield bonds have similarly eased, although like most things in 2020, some funds have performed better than others. One particular bright spot in the sector is the performance of so-called “Fallen Angels”, which are bonds issued by companies that were once investment-grade, but have recently had their credit ratings downgraded to “high-yield” status. When those downgrades occur, many institutional investors are forced to sell their holdings of those companies’ bonds, often creating market inefficiencies that purchasers of these “Fallen Angels” can exploit. And indeed, 2020 has been a big year for credit downgrades, with well-known companies like Ford, Delta, Kraft Heinz, and Macy’s all falling below investment grade and into the realm of high-yield bonds.

Aggressive actions from the Federal Reserve proved to be a boon for high yield bonds in general, and the recovery in the sector was rapid, with yields quickly returning close to their 2019 levels. Performance for the “Fallen Angels” was particularly strong, with the higher-quality portion of the high-yield space dramatically outperforming the lowest-quality companies that comprise some of the broader high-yield bond funds. Further downgrades could put renewed pressure on the corporate bond sector, but for now, it looks like the contrarian approach employed by investing in “Fallen Angels” will have paid off nicely in this highly-volatile year.