Fallen angels are bonds issued by companies that previously held an investment grade rating, such as BBB at S&P, but were downgraded into the high yield segment. In simple terms, a formerly solid issuer loses its investment grade status and moves into the more speculative high yield category. A typical example is a downgrade from BBB to BB. Once downgraded, these bonds are traded in the high yield market, often at a price discount. Rating agencies such as Standard & Poor’s, Moody’s and Fitch issue these downgrades based on factors such as weaker financial performance, rising leverage or adverse sector trends.

The boundary between investment grade and high yield acts as a hard threshold. When an issuer falls below this line, the market often reacts immediately. Many institutional investors are required to sell such bonds due to internal guidelines that limit high yield exposure. Passive index products follow similar rules. If a bond drops out of an investment grade index, it is removed from ETFs at the next rebalancing date, which adds further selling pressure. As a result, widespread forced selling can push prices lower and increase the yield of the affected bond. While the higher yield appears attractive, it also reflects increased credit risk.

Fallen angels tend to occur more frequently during periods of economic stress, such as the COVID-19 downturn in 2020, when several large airline bonds lost their investment grade status.oder Branchenkrisen, wenn sich die Bonität vieler Unternehmen gleichzeitig verschlechtert.

The emergence of fallen angels is closely linked to the economic and credit cycle. In periods of economic expansion, downgrades are less common and many issuers even improve their credit quality, becoming so-called rising stars. During economic downturns or sector-specific stress, the number of fallen angels typically increases. Recent data illustrates these cyclical patterns: In 2024, the US market recorded only six new fallen angels with a combined volume of USD 6.7 billion, the lowest figure on record and far below the long-term average of roughly USD 50 billion per year.

For 2025, market analysts expect a significant increase in downgrades back into non-investment-grade territory. Forecasts suggest around USD 50 billion in new fallen angels in the US alone, close to the historical average. Notably, this expected rise in downgrades does not coincide with expectations of higher default rates. In other words, a larger wave of fallen angels could occur without widespread insolvencies. This combination — more downgrades but stable default rates — makes fallen angels a particularly relevant segment for credit investors in 2025.

Several factors can increase the likelihood of fallen angels. Higher interest rates raise refinancing costs; issuers at the lower end of the investment grade spectrum are especially sensitive when older bonds mature and new debt must be issued at higher yields. As extraordinary monetary support normalizes, liquidity conditions may tighten and economic momentum may slow. These dynamics particularly affect the weakest investment grade issuers, increasing downgrade risk. For active investors, such phases often bring a broader set of fallen angel opportunities.

Fallen angels combine attractive return potential with risks that should not be overlooked. A balanced assessment requires understanding both sides.

Opportunities

• Attractive yields:
  Following forced selling by investors with strict rating mandates, fallen angels often trade meaningfully below par. As a result, their effective yield can be higher than that of comparable bonds that have not been downgraded. Early 2025, yields in a representative fallen angels index were around six to seven percent, broadly in line with the wider high yield market. Investors are compensated with a higher credit spread for assuming additional risk.
• Potential for price recovery:
  Fallen angels can exhibit strong recovery potential. If the downgrade was excessive or the issuer’s fundamentals stabilize, bond prices may rebound. Historically, fallen angels have often outperformed the broader high yield universe over one- to two-year periods. Over longer horizons, they have even outperformed many investment grade indices. This is known as the fallen angels effect – a structural phenomenon resulting from the boundary between investment grade and high yield, which can create opportunities for investors.
• Re-rating potential:
  A meaningful share of fallen angels eventually return to investment grade status and become rising stars. According to long-term Moody’s data, nearly one quarter of fallen angel issuers were upgraded again within a twenty-year period. When such a recovery occurs, investors can benefit twice: from higher yields after the downgrade and from capital appreciation upon re-rating. This creates opportunities for active strategies focused on identifying issuers with resilient business models and credible improvement potential.

Risks

• Deteriorating credit quality:
  Downgrades do not occur without underlying reasons. Issuers may face high leverage, declining profitability or sector-specific headwinds. Roughly half of all fallen angels remain in high yield for extended periods, and some never recover. In more severe cases, issuers may experience financial distress. Studies indicate that around twelve percent ultimately default. This can lead to material losses for investors.
• Volatility and liquidity risk:
  After a downgrade, price volatility typically rises. As large segments of the market reduce exposure, spreads can widen significantly. Liquidity may temporarily decline, especially when many fallen angels reach the market simultaneously, such as during recessions. Although persistent illiquidity is rare outside extreme scenarios, investors must be prepared for short-term price fluctuations.
• Selection risk:
  Not all fallen angels are undervalued opportunities. Some issuers face structural challenges that may lead to further downgrades or even default. Investing indiscriminately across all fallen angels can expose portfolios to distressed debt situations. Thorough credit analysis is therefore essential to distinguish between fundamentally stable issuers and those with sustained credit deterioration.

Interim conclusions 

Fallen angels offer compelling opportunities but require careful analysis. For investors with an informed approach—or those who prefer to rely on specialised credit managers—they can play a valuable role in a diversified portfolio. Investors without the resources for detailed credit work should approach this segment with caution.

Investors can access the fallen angels segment either through passive solutions such as index-based ETFs or through active strategies with targeted security selection. Both approaches have strengths and limitations. In the case of fallen angels, active management can be particularly relevant.

• Passive Approach – Fallen Angels ETFs
  In recent years, several index solutions and ETFs focused specifically on fallen angels have been launched. These products track indices such as the Bloomberg Barclays Fallen Angel Index, providing broad and systematic exposure to downgraded issuers. The main advantage is convenience: Investors gain diversified access without performing individual credit analysis. Historical index data shows that fallen angels indices have frequently delivered competitive returns.

  However, passive strategies follow rigid rules. Index ETFs purchase fallen angels based solely on rating events and inclusion criteria, regardless of an issuer’s underlying credit quality. As a result, portfolios may include issuers facing significant structural challenges. In addition, index inclusion and removal often happen with a lag – typically at scheduled rebalancing dates. By the time an ETF buys a fallen angel, the largest part of the price adjustment may already have occurred. Passive strategies therefore tend to be trend-followers: They buy after a downgrade-driven sell-off and sell when an issuer is upgraded again, as required by index rules.

• Active Management – Selective Fallen Angels Strategies
  Active managers have greater flexibility. A selective fallen angels strategy focuses on identifying issuers where the market reaction may have been excessive and where credit fundamentals remain stable or offer improvement potential. Through detailed credit analysis, active managers aim to avoid issuers where the downgrade reflects deeper structural problems and further credit deterioration is likely.

  Active investors can also respond faster than index vehicles. They can adjust allocations at the first signs of rising downgrade risk, reduce exposure to vulnerable BBB issuers, build liquidity to take advantage of dislocations or purchase bonds before index-driven selling pressure has fully subsided. This timing flexibility can be an advantage, especially during periods when downgrades cluster in specific sectors.

  Active strategies allow for targeted sector and regional positioning as well. Fallen angels often occur in waves within individual industries – such as energy during periods of sharp oil price declines. An active approach can overweight sectors with improving fundamentals and avoid those with structural headwinds.

Overall, a disciplined active framework can help capture the return potential of fallen angels while managing downside risks. However, this requires analytical resources, experience and a robust risk management process. For many investors, a professionally managed fallen angels strategy may therefore be a suitable way to access this segment.

Fallen angels bonds offer return-oriented investors an interesting segment with elevated yields and the potential for price recovery. The key question can be answered clearly: An allocation to fallen angels can be attractive, provided the selection is disciplined and the underlying risks are understood. History shows that downgrades are not necessarily a reason for concern. In many cases, fallen angels become attractive opportunities once the initial selling pressure subsides.

A careful approach is essential. Investors who analyse issuer fundamentals thoroughly, act with appropriate timing and diversify across issuers with solid credit profiles can benefit from both higher yields and potential price appreciation. For long-term, highly risk-averse investors without the resources for detailed credit analysis, this segment can be demanding. In such cases, delegating the selection to experienced portfolio managers may be more suitable.

Overall, periods of market stress often create opportunities. With the right expertise and a structured investment process, fallen angels can contribute meaningfully to portfolio returns.