Fallen Angels, internal rate of return, quality dividend funds, volatility & credit risk.

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What do you think of quality dividend ETFs for long term investing?(E.g. - iShares MSCI Europe Quality Dividend UCITS ETF EUR (Dist) EQDS:LSE:GBX - iShares MSCI USA Quality Dividend UCITS ETF USD (Dist) HDIQ:LSE:GBX)

UK high dividend funds such as IUKD don’t come with these filters for sustainable dividend 


iShares has three of these quality dividend ETFs, one which is for global equities, one which is for European stocks and one for US equities.


The funds are

  • The dividend yield is a measure of how much a company pays out in dividends each year relative to its share price.
  • The benchmark index excludes any Real Estate Investment Trusts (REITs, i.e. closed-ended investment vehicles that invest in, manage and own real estate) that are part of the parent index.
  • In order to create the benchmark index, the index provider (MSCI) applies a dividend income and quality screening process to the companies which make up the parent index with REITs excluded. This screening process excludes companies
    • (i) whose dividend payments are extremely high (i.e. in the top 5% of constituents, on the basis that dividend payments which are particularly high relative to a company’s earnings could be unsustainable) or negative
    • (ii) which do not have a good track record of growing dividends
    • (iii) which could be forced to cut or reduce dividends due to potentially weak fundamentals (i.e. information about a company which can be expected to impact the price or value of its shares, including profitability, consistency of earnings over time and debt levels)
    • (iv) which rank lowest among the remaining constituents based on recent annual performance.
  • From the list of companies which remain after this screening process, only those with a higher dividend yield relative to the parent index will be included in the benchmark index yield relative to the parent index will be included in the benchmark index.

How to interpret “Internal Rate of Return”? (A.K.A. money-weighted return or personal rate of return)

This is how Vanguard’s tooltip describes the internal rate of return:

Rate of return that

  • If all past investment amounts are invested at that rate they will lead to the value of the portfolio today
  • All past investments discounted at that rate will give a total present value of zero

Is there any evidence that "Fallen Angel" bonds which have been downgraded from investment-grade are indeed then "over sold" by institutional managers and hence provide an opportunity?  (iShares Fallen Angels High Yield Corp Bond UCITS ETF (RISE) is an example of an ETF in this area)

Yes, but… it comes from the index constructors such as Russell

https://www.ishares.com/uk/individual/en/products/283872/ishares-fallen-angels-high-yield-corporate-bond-ucits-etf launched 2016-06-21

For example, here’s the fact sheet for... 

  • The FTSE Time-Weighted US Fallen Angel Bond Select Index is designed to measure the performance of “fallen angels” – bonds which were previously rated investment-grade but were subsequently downgraded to high-yield
  • The index is based on the FTSE Time-Weighted US Fallen Angel Bond Index which includes US Dollar-denominated bonds issued by corporations domiciled in the US or Canada that meet additional inclusion criteria.
  • Any such bonds with a rating changed from investment-grade to high-yield in the previous month are eligible for inclusion in the index and will be held in the index for a period of 60 months from inclusion provided they continue to meet the inclusion criteria.
  • If a bond exits and then re-enters the index, the inclusion period is reset.
  • Unlike traditional indexes where constituent weights are based on market value, the constituent weights of the FTSE Time-Weighted US Fallen Angel Bond Select Index are determined based on the time from inclusion in the index. Higher weights are assigned to bonds that have more recently become “fallen angels.
  • This time-based weighting approach aims to capture the potential price rebound effect that fallen angels may experience soon after their initial downgrade to high-yield.


  • Intuitively this outperformance makes sense
    • Selloffs in credit are like those in equity, markets overreact then the price bounces back
    • Institutional investors are forced to sell a bond that is sub-investment-grade because their mandate is to buy only IG debt. They tend to hold very large amounts so selling makes a huge price impact due to the illiquidity of high yield credit.
    • The time-weighted index benefits from the bounce back in price that usually comes after a selloff
    • Correlation with equity of HY credit tends to be high, but is lower for fallen angels
    • Long duration could be a problem if rates rise, a benefit if rates fall
  • This article is by Robin Marshall who’s in fixed income research at FTSE Russell https://www.etfstream.com/feature/9202_ftse-russell-fallen-too-far-what-sets-fallen-angels-apart/

Is there any relationship between volatility and credit risk or duration risk? If not, does it still make sense to use volatility as risk proxy for corporate bonds?

  • Bond volatility for corporate bonds
    • Doesn’t capture credit risk
    • Does capture duration risk
  • Watch out on FRED for credit spreads e.g. BB spreads are here and if credit conditions worsen this spread will increase almost immediately https://fred.stlouisfed.org/series/BAMLH0A1HYBB
  • The Merton model makes a beautiful link between equity volatility and credit risk
  • It treats equity like a call option on the assets of a company at a future time T
  • If the assets are worth more than the debts at time T you profit from the excess
  • If the assets are worth less than the debts at time T you lose all of your investment as the company is bankrupt
  • The distance to default is the amount by which the assets exceed the liabilities in standard deviation units

Equity Price equals delta times asset value minus debt value times p open paren survive to cap T without default close paren⁣


E sub 0 equals A sub 0 N of open paren d sub 1 close paren minus D e raised to the negative r T power N of open paren d sub 2 close paren⁣

d sub 1 equals the fraction with numerator l n the fraction with numerator A sub 0 and denominator D plus r T plus one half sigma sub A squared T and denominator sigma sub A the square root of T⁣

d sub 2 equals the fraction with numerator l n the fraction with numerator A sub 0 and denominator D plus r T minus one half sigma sub A squared T and denominator sigma sub A the square root of T⁣

sigma sub E equals sigma sub A N of open paren d sub 1 close paren the fraction with numerator A sub 0 and denominator E sub 0⁣

p sub default asymptotically-equals the fraction with numerator s and denominator 1 minus R asymptotically-equals the fraction with numerator l n N of open paren d sub 2 close paren and denominator T⁣

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November 7, 2019