Fallen angels are exiles from investment grade heaven. Once downgraded to junk, some fund managers shun them because of their past. Bonds that began as investment grade, for instance, typically have fewer covenants to protect investors than high-yield bonds. Yet fallen angels seem to be better investments than bonds that start out as junk.

This outperformance is decisive, with total annual returns approaching 10 per cent against just more than 5 per cent for “original issue” junk bonds, according to Martin Fridson of Leverage World. The trend has held, even on a quarterly basis, for nearly 10 years, a full credit cycle. It applies on a risk-adjusted basis as well, in spite of higher volatility. (Standard & Poor’s calculates fallen angels are more likely to default than original issue bonds but also more likely to recover.)

Why should this be? The average fallen angel is rated slightly above other junk bonds, perhaps explaining a fraction of the difference. Another hard-to-test explanation is that when angels initially fall – Ford and General Motors last year, for example – they are oversold, making them initially cheap in the high-yield market. Company management may also be more genuinely committed to regaining their old status than junk borrowers who have never known anything else. Structure is another factor. High-yield bonds can usually be bought back for a few points more than par value. Intuitively, this could limit investors’ upside on original issue bonds more than on fallen angels that have a history of trading below par.

The current tendency to create junk-rated companies deliberately – through leveraged buy-outs or recapitalisations – could result in fallen angels that do less well than accidental visitors from heaven. That aside, history suggests the bonds – almost a third of the junk bond market according to Merrill Lynch – are more virtuous than they sound.