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Is investing in ‘fallen angels' a worthwhile investment strategy?

by , 24 November 2015

One popular and successful investment strategy is momentum investing. This involves investing in shares that are soaring in value, making the most of the current trend.

Yet there are some investors who take the opposite approach to investing. This involves investing in shares that have dropped greatly in value and buying bonds downgraded to junk status.

So is this fallen angels' investment strategy worth pursuing?

Let's take a closer look…

What does the fallen angels’ investment strategy entail?

The basis of this investment strategy is that when a share price falls sharply, investors have a higher tendency to overreact. All the forced sellers in the market push the price down further letting fallen angel investors pick these shares up at rock bottom prices.
With bonds it means picking up lots of bonds the large institutions have had to sell due to their downgrading. Again, the sheer number of forced sellers pushes the price down.
Take the Bank of America Merrill Lynch Fallen Angels Index, Matthew Partridge in Money Week explains. It gave a total return of 199% between 2003 and 2015, that’s much higher than the performance of the Morningstar High Yield Bond Index.
Doing this sort of investing isn’t easy, but there are funds on the market covering this style of investing. These funds include the Market Vectors Fallen Angel High Yield Corporate Bond ETF [NYSE:ANGL].
Going back to the stock market, research shows that there are merits to this fallen angels’ investment strategy. Over time, shares that haven’t done well will eventually will do better than those that have done well.

Does the fallen angels’ investment strategy work?

Take a study done by Werner De Bondt and Richard Thaler in 1985. They found portfolios holding the worst performing stocks over the past year tended to eventually beat the performance of the portfolios containing the best stocks.
But it’s not as simple as that. There are various things that can interfere with this performance. For instance, the strategy appears to work better at the end of the US tax year, but at other times of the year doesn’t work well.
To get by this problem, you can look to sectors and countries which have fallen in value to see if you can find any shares trading at bargain prices. 
So there you have it. Why investing in ‘fallen angels’ could be a worthwhile investment strategy.
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