The developments in credit markets since 2000 have shown that a disciplined approach to minimize risk is necessary. This includes the determination of stop-loss marks which have to be defined on a caseby- case basis. Important is the volatility of the particular bond and the risk profile of the portfolio. Aportfolio with a high-yield benchmark will be able
to take the highest volatility but a buy-and-hold strategy is also not compatiblefor such a portfolio if a specific bond has to suffer a huge price loss.
The price mechanism of Fallen Angels and high-yield bonds requires disciplined stop loss marks. Fallen Angels tend to trade on very wide levels prior to a downgrade in high yield but a downgrade will usually induce another sell-off in the bonds so that a significant price fall will occur.
Besides fundamental facts, technical factors play an important role and current risk appetite of investors determines basically a floor for the Fallen Angel. If new buyers arise upswings in price can be significant, supported through positive credit news.
A simple approach is to differentiate between short-term and long-term liquidity constraints and the reasons leading to the constraints. If deteriorating fundamentals are the driving force, an indepth credit analysis should specify the point in time when a company will run out of cash. The thing an investor has to decide is whether current trading levels compensate sufficiently for the uncertainty of improving fundamentals and hence the ability to preserve enough liquidity in the long term.
