Tabula Investment Management has introduced a sterling-hedged share class of the Tabula Global High Yield Fallen Angels Paris-aligned Climate UCITS ETF, an innovative Article 9 ETF providing exposure to so-called ‘fallen angel’ bonds while adhering to the climate objectives of the Paris Agreement.

Stefan Garcia, Chief Commercial Officer at Tabula Investment Management.

The new GBP-hedged share class (Ticker: TFGD LN) has been listed on London Stock Exchange with an expense ratio of 0.55%, complementing the existing unhedged US dollar-denominated share class (THFA LN) which launched in June and has an expense ratio of 0.50%.

Fallen angels are bonds that were originally issued with investment grade status but have since been downgraded to junk.

The strategy of investing in fallen angels is based on the premise that the overly negative sentiment surrounding a downgrade into junk territory causes fallen angel bonds to be regularly oversold as investors, often forced by their investment mandate, sell en masse prior to and at downgrade, leading to a price anomaly.

Tabula notes that fallen angels have historically delivered superior returns compared to the broader high yield market. The firm attributes this outperformance to characteristics such as a relatively higher credit rating (approximately 80% of fallen angels hold a BB rating compared to around 50% for the broader high yield market), lower default rates, and the fact that fallen angels tend to be bonds from larger, well-established businesses that are particularly focused on returning to investment grade in order to access cheaper borrowing.

Tabula notes that its latest ETF has come to market just as investors are turning their attention back towards riskier segments of the global bond universe – in the first seven months of 2023, European-listed high yield fixed income ETFs recorded over $4 billion net inflows, compared to $5bn of outflows for the same time period last year.

Stefan Garcia, Chief Commercial Officer at Tabula Investment Management, commented: “As investors redress imbalances in their portfolios, having been underweight fixed income over the past decade, our latest listing for UK investors provides a climate-based solution with an attractive yield.”

Methodology

The fund is linked to the Bloomberg MSCI Global Corporate Fallen Angels Paris-Aligned Index which is based on a parent universe consisting of fallen angel bonds from developed market corporate issuers. Eligible bonds may be denominated in US dollars, euros, pound sterling, Swiss francs, Swedish krona, Norwegian krone, or Danish krone.

The original universe only includes fixed-rate issues with at least one year remaining until maturity, a credit rating between B- and BB+, and a minimum issue size of 150 million (USD, EUR, GBP, CHF).

It should be noted that the parent universe is ‘time-weighted’ in that it overweights newer fallen angels, an approach that seeks to increase exposure to potential rebounds (many fallen angels tend to bounce back strongly, performing well within the first 18 months since their downgrade).

The index construction methodology harnesses insights from MSCI ESG Research to exclude violators of UN Global Compact principles, companies embroiled in severe ESG-related controversies, and firms with business activities linked to weapons, tobacco, thermal coal, oil & gas, alcohol, adult entertainment, and cannabis.

The remaining constituents are then re-weighted using an optimization process, run on a monthly basis, that is designed to satisfy the requirements for an EU Paris Aligned Benchmark (PAB), aligning with a trajectory to limit global warming to 1.5°C above pre-industrial levels by 2050. Specifically, the index delivers an immediate 50% reduction in weighted average carbon intensity (based on Scope 1, 2, and 3 emissions) compared to the initial universe as well as a 7% annual decarbonization going forward.

The optimization also seeks to achieve secondary objectives such as increasing exposure to companies with higher ‘green’ revenues, minimizing turnover to a maximum of 2%, boosting yield-to-worst to a level that is higher than the parent universe, maintaining an option-adjusted duration within three months of the parent universe, and minimizing absolute deviations in constituent weights compared to the parent universe. These secondary objectives may be relaxed, however, to ensure compliance with the PAB requirement.