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US corporate downgrades have been less common in recent years, but we expect the tide to finally turn. Our systematic fixed income team projects c.$50bn of new US fallen angels in 2025. This could create a unique environment of high downgrades but low defaults. Fallen angels could therefore become one of fixed income’s most compelling opportunities this year.
Figure 1: We project US fallen angel downgrades will return to historical averages1
Fallen angels have been in short supply, but that could be about to change
‘Rising stars’ (issuers upgraded to investment grade) have outnumbered ‘fallen angels’ (downgrades to high yield) in recent years.
There were six new fallen angels in the US market in 2024, for $6.7bn in volume, the lowest on record and far lower than the c.$50bn annual average since 20042. Rising stars were $10.3bn versus a historical average of $18bn.
Figure 2: The fallen angels universe has been shrinking, but that could be about to change1
Economic conditions have helped prevent downgrades. The US economy recovered strongly from the pandemic and central bank stimulus has helped keep credit spreads contained. Companies also termed out their debt in 2020, partly shielding themselves from rising rates.
However, these conditions are gradually reversing. Coupons and yields are starting to converge as issuers refinance (Figure 2), the Fed is reducing its balance sheet (so far from 37% of GDP in 2021 to 24%3) and economic growth is moderating.
Figure 3: Rising interest costs could impact the more vulnerable US BBB corporates4
Further, the labour market is delicately balanced, resulting in signs of stress at the lowest income and wealth consumer cohorts. In addition, newly emerging political risks around tariffs and fiscal policy have introduced greater uncertainty.
We believe these elements may impact BBB corporates that may be on the cusp of a downgrade to high yield.
However, the tide could be about to turn
In our view, c.$50bn of the $3.2trn BBB universe are solid downgrade candidates.
A large proportion of BBB- (the lowest investment grade cohort) corporates are trading at wider spreads than BB peers, implying the market considers them more high yield than investment grade. Ratings agencies have $387bn of BBB corporates on negative outlook, the highest (outside the pandemic) since at least 20105.
Figure 4: A screen of the BBB universe indicates a downgrade cycle could be imminent6
| All BBB- rated bonds | Issuers | Par Amount ($ billions) |
| Total outstanding | 211 | 772 |
| One HY rating | 37 | 206 |
| Two negative outlooks | 23 | 195 |
| Trading at wider spreads than comparable BBs | 132 | 326 |
Insight’s team, currently projects c.$50bn of fallen angels over the near to medium-term (Figure 4 – left). This also comports with sell-side outlooks for 2025 (Figure 4), which show a median of $45bn excluding Boeing7 (which has $53.6bn of bonds outstanding alone).
Figure 5: Insight’s machine learning predictor also indicates rising downgrades to fallen angel status8
Downgrades are a potentially exciting development for fixed income investors
It may seem counter-intuitive, but downgrades, particularly downgrades to fallen angel status, can be particularly compelling fixed income opportunities.
These downgrades can create predictable and potentially exploitable volatility. When an investment grade bond is downgraded to high yield, bonds suffer ‘forced selling’ from passive investment grade accounts. This typically exacerbates the bond’s underperformance, allowing investors to purchase the issue at potentially cheap valuations.
Since 2004, on average excess returns on fallen angels have been -10% over the six months before a downgrade, but +20% over the 12 months after, well in excess of other BB corporates (Figure 3). Rising stars have also been historically more than twice as likely to be a former fallen angel than an original issue high yield bond9.
Figure 6: New fallen angel downgrades have historically created predictable volatility10
Once downgraded to high yield, fallen angels are typically incentivised to shore up their balance sheets, in the hopes of reattaining investment grade status, to manage their borrowing costs and access to funding.
A key reason why an influx of fallen angels may be exciting is because we expect it to be paired with a benign default environment. In our view, high yield fundamentals are compelling. We also see structural high yield market changes. For example, high yield has been less of a financing vehicle for LBOs in recent years with many borrowers looking to private credit markets instead. Further, there have been increased incidences of distressed exchanges (which historically have higher recovery trades than more traditional defaults).
A systematic approach may be a compelling way to access fallen angels
Most traditional passive and active managers may struggle to invest in fallen angels as a standalone allocation. As such, relatively few strategies exist that target fallen angels exclusively.
Liquidity and trading frictions are the main hurdles. When trading bonds one at a time over the counter (which is the traditional method), fallen angel bid-ask spreads have typically been 90bp to 100bp.
However, we find we can enhance liquidity through ‘credit portfolio trading’, a protocol we began developing in 2012 by exploiting liquidity within the ETF ecosystem. It can reduce fallen angel transaction costs to 40-50bp with the capacity to transact up to $200m daily. In our view this is essential when dealing with fleeting value in harder-to-access bonds.
Conclusion: fallen angels could be the fixed income opportunity to watch in 2025
We believe a downgrade cycle, but not a default cycle, beckons for investors. We believe investors positioned to purchase fallen angels after they are downgraded have the potential to benefit the most. In our view, this means investors should consider an approach that can target fallen angels as a standalone asset class.
