‘Don’t throw baby out with bath water,’ Astute Investors say
Asian high-yield bonds offer opportunities, but investors need to be selective
The news of the US Federal Reserve’s decision to end its bond-buying programme back in 2013 was greeted with alarm. Investors started pulling out of the bond market, sending the yields soaring.
Five years later, the market could be witnessing another taper tantrum. Rising interest rate is dampening investors’ confidence on companies’ repayment capability, especially high-yield borrowers’ ability to service or refinance their debt. Investors are also expecting rising defaults and re-pricing of risky assets.
“Against a backdrop of poorer macro pressures stemming from FX vulnerabilities, companies will face pressure from FX mismatches, which may dent the EBITDA (earnings before interest, taxes, depreciation, and amortization) outlook,” says Jonathan Siow of Amundi in Singapore.
Also weighing on sentiment is the US-China trade war. Bao Vo at TIAA Investment suggests that the market has yet to see the trade war’s full impact. “The increasing tension between the US and China, which will impact growth, isn’t fully priced in yet.”
Against a background of a gloomy market environment, investors remain generally optimistic about Asian bond markets.
Asset Benchmark Research’s (ABR) most recent survey of investors finds that the majority of investors (75%) see relative value in Asian debt markets, particularly in high-yield bonds.
Asian high-yield bonds are expected to outperform investment-grade securities amid availability of credit and low sensitivity to US treasuries’ movement. But it pays to be selective.
“Asian high-yield is probably one of the cheapest high-yield segments globally for a strong set of fundamentals,” says Dhiraj Bajaj, head of Asia fixed income at Lombard Odier. “Capital comes back into the asset class through cycles, this segment will undoubtedly provide double-digit returns.”
Chris Sano at UK-based Ox Global Investments says, “we will be trading bonds very selectively”. “We expect a lot of short-term pain for global debt markets that Asia won’t be able to escape. We will be looking to pick up bonds should the next financial crisis materialize,” he adds.
Sano isn’t alone in this plan. In the event of another sell-off over half of investors (55%) will acquire more Asian bonds, the survey revealed.
Summing up the responses from more than 300 investors, short-dated papers are most appealing to Asian fixed income investors.
“Asia currently offers good fundamentals, and due to the risk of higher interest rates in the US, short tenor bonds offer better protection for investors,” says Alexander Zeeh, CEO at S.E.A. Asset Management.
Apart from shorter tenor, investors seek quality securities. “Liquidity for refinancing is going to get tighter so there shall be no compromising to credit quality and repayment capability when it comes to our security selection,” explains Clifford Lau, head of Asian fixed income at Columbia Threadneedle in Singapore.
Among Asian high-yield bonds, investors are most optimistic about Chinese real estate companies.
“The contracted sales growth for the mid- to large (Chinese) developers are still growing. Profitability remains healthy. Financing channels are getting tight, but manageable despite increasing financial cost and policy risks. It is still an offshore investor favoured industry compared to non-property or over-supply sectors. Plus the recovery value of Chinese property developers is high,” says Kenny Chung, senior credit analyst at Gaoteng Global Asset Management.
Property companies usually run a fast asset turnover strategy. Developers offer higher interest in exchange for capital it requires for refinancing and capital expenditure.
“I still see value in the China high-yield property developers’ bonds, but near term I see limited upside for capital appreciation. Fundamentally speaking, large property developers will continue to benefit from the sector consolidation trend, and have access to multiple funding channels and diverse land banks,” says Jintao Liang, a portfolio manager at Baring Asset Management.
Yet some investors worry that the adequate funding channels may not be enough to counter the impact of slowing demand. Franklin Au Yeung, head of fixed-income at AIA, comments that the high-yield property developers in China will face an “uphill battle against policy controls over demand and prices on residential properties amid a decelerating economy”.
Another high-yield segment investors are looking at is the local government financing vehicle or LGFV (城投信仰). While it’s true that investors’ unconditional confidence in LGFVs has started to wane, some investors remain supporters of LGFVs that have “strategic significance” to the economy.
“Investors need to (be) extremely selective on Asia high-yield bonds. Unlisted and opaque credits, despite the sell-off don’t offer good risk-reward as idiosyncratic risks continue to be high. Also investors need to be careful on LGFVs, especially those that are unrated, whose policy role or linkage to the local government is in question,” Abhijeet Neogy of global advisor PIMCO Asia says.
Ray Gu at Bosera Asset Management, a local investor, says, “we’re generally constructive on Chinese LGFVs with regional strategic importance, and high-yield state-owned enterprises. They will benefit from domestic policy changes and relatively favourable liquidity conditions.”
Another high-yield segment worth noting is Indonesia’s coal sector. “We still like Asian coal and oil credits as the commodity cycle is being extended by China’s Belt and Road initiative,” says Desmond How, head of fixed income at Gaoteng Global Asset Management.
“Some Indonesian high-yield bonds are pricing in too high default probability – the coal sector bond is an example, especially when coal prices are high and well-supported by demand growth,” says Abhishek Rawat, China Merchants Securities Investment Management.
“After the sell-off in the first half of 2018, if you look at Asia JP Morgan HY index yield, it is offering a yield of 8% on average. This is similar to the taper tantrum in 2013. We like Indonesian high-yield names like coal companies where the fundamentals are better and they have a natural hedge against the strengthening US dollar,” states Rachana Mehta, regional co-head of fixed income at Maybank Asset Management.
Going forward, political and economic factors are likely to impact Asian high-yield bonds’ performance. In China, for example, ambiguity around its deleveraging and stable growth policies poses as a risk factor. For the most part of 2017 and early 2018, government attitude toward deleveraging had been progressive. But that changed after China’s trade dispute with the US erupted.
People’s Bank of China (PBoC) governor Yi Gang mentioned a “structural optimization of the leverage ratio”, in a local media interview, citing the declining leverage ratio at state-owned enterprises as well as reduced cost of local debt. While China remains ambiguous on the matter, it appears that the government’s deleveraging efforts have been put to a halt indefinitely.
In Indonesia, the upcoming election in April is being watched closely by the market.
“After the sell-off in the first seven months of 2018, we started to find relative value for select Asian high-yield bonds especially from the property sector within three years of duration. Indonesian property sector, however, may face further downside risk given the general election in April 2019, which will continue to dampen housing demand,” says Mark Lo, head of fixed income at AMTD Global Markets.
Probably the biggest risk to the sector is the ongoing US-China trade war. “The trade dispute between China and the US could potentially benefit certain Asian countries due to a change in supply chain,” says Paula Chan at Manulife Asset Management. Certain sectors in China, however, will bear the brunt of the trade dispute. Franklin Au Yeung, head of fixed-income at AIA, says “sales volume and margin are likely to be affected even as the government introduces economic policy stimulus to counteract the impact of rising trade tariffs on its exports. China industrials would also suffer from the slowing economy as well as the policy ambiguity between growth and deleveraging”.