Extra Credit

Many investors react to short-term news. Others may emphasize beta, want to replicate a benchmark or have inflexible guidelines, so they may take a less discriminating approach to portfolio holdings. On the Full Discretion team, we utilize a top-down credit cycle framework to analyze changing credit conditions, which provides a common language and boundaries for credit cycle phases. At its core, our credit cycle framework measures the ebb and flow of credit and creates a familiar pattern of “boom-and-bust” asset price cycles.

Because we invest over the long term and consider where we are in the credit cycle, we also maintain security selection disciplines that can create entry points for us. Through fundamental research and active management, we seek to capture risk premiums that other investors may be unable or unwilling to access. We consistently use six security selection strategies to help identify and capitalize on mispricings throughout market cycles, and fallen angels are a prevalent strategy in the expansion to late cycle environment, which is where we are currently.

In late cycle, corporate profits are increasingly under pressure, which can result in balance sheet deterioration. When firms struggle to generate profits, shareholder-friendly activities take precedence to boost earnings per share. In this environment, credit ratings become vulnerable, making downgrades across the ratings spectrum more likely. This dynamic creates opportunities for fallen angels, which is exactly what we’ve seen year-to-date.

What is a Fallen Angel?

Fallen angels are companies that have their credit ratings downgraded from investment grade to below investment grade, or high yield. Many investors must sell downgraded bonds when they fall out of investment grade indices. This reflex can push bonds below fair value and inflate their yield. It has also helped fallen angels’ return profile over time. Over the past 15 years or so, fallen angels have outpaced high yield and crossover credits on a total return basis and bested high yield for return per unit of risk. Their return per unit of risk is roughly in line with that of crossover credits but with higher total return potential and volatility.

Fallen angels are often considered to be a higher-risk segment of the market, and we believe fundamental research and valuation analysis are crucial for investing in this space. Research demonstrates the importance of identifying potential fallen angels more than six months before downgrade while simultaneously having the guideline flexibility to purchase them in advance of or once they are downgraded to high yield.

Year-to-date, fallen angel volume is pacing at a five-year high at nearly $60B.¹ For example, Warner Bros. Discovery (WBD) became one of the largest fallen angels into the high yield market earlier this summer after electing to split into two distinct businesses. Legacy media companies are adjusting to an “on-demand” world and WBD is no exception, with WBD separating into a Networks business and a Studios and Streaming company. We believe fallen angels, in this example, are an opportunity worth consideration. While WBD’s fundamental credit story is challenged, and questions remain about the optimal capital structure, there is still large issuance across a variety of maturity levels.

Where is the Potential Opportunity?

Looking ahead, as investors continue to confront questions related to the health of the economy and the dynamic scope for fallen angel candidates, they should keep a close eye on this attractive segment of the market in relation to the phases of the credit cycle. Investors who can unlock the credit cycle while understanding the interaction between spreads and asset prices have the potential to generate attractive risk adjusted returns.

¹Source: J.P. Morgan, as of 7/31/2025.

Important Disclosure

This marketing communication is provided for informational purposes only and should not be construed as investment advice. It is meant to offer a snapshot of select market developments and is not a complete summary of all market activities. Investment decisions should consider the individual circumstances of the particular investor. Any opinions or forecasts contained herein reflect subjective judgments and assumptions of the author and do not necessarily reflect the views of Loomis, Sayles & Company, L. P. Investment recommendations may be inconsistent with these opinions. There can be no assurance that developments will transpire as forecasted. Data and analysis does not represent the actual or expected future performance of any investment strategy, account or individual positions. Accuracy of data is not guaranteed but represents our best judgment and can be derived from a variety of sources. Opinions are subject to change at any time without notice.

Commodity, interest and derivative trading involves substantial risk of loss.

Diversification does not ensure a profit or guarantee against a loss.

Market conditions are extremely fluid and change frequently.

Any investment that has the possibility for profits also has the possibility of losses, including loss of principal.

There is no guarantee that any investment objective will be realized, or that the strategy will be able to generate any positive or excess returns.

Past performance is no guarantee of future results.

For Institutional Use Only. Not For Further Distribution

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