Asian high yield bond, is it a good investment option?
15 OCT, 2021
By Constanza Ramos
Asian high yield bond has been avoided by investors in the recents months due to the recent events happening in the Asian market, however, it could be an interesting opportunity for investors who have the risk tolerance to ride through short term market volatility. We have spoken to the fund managers of the Allianz Dynamic Asian High Yield Bond, and the Matthews Asia Funds - Asia Total Return Bond Fund, to understand what is the current situation of the market, what are the strategies they are following at the moment, and what we can expect in the next 12 months.
Allianz Global Investors Fund - Allianz Dynamic Asian High Yield Bond
Mark Tay, Portfolio Manager, Allianz Dynamic Asian High Yield Bond
Recent high profile credit events do not pose systemic risks for China
It started with the news of China’s largest property developer facing funding difficulties that turned into fears that a potential default that could bring about broad contagion risks to the China’s financial system and economy. Since then, the company has missed its coupon payment due date and looks to be headed towards an orderly debt restructuring, putting to rest fears that this could have possibly been China’s “Lehman” moment, which was clearly overdone.
Fears of collapse of China’s property sector overdone
Physical property market sales growth has indeed slowed from the start of the year. However, this moderation in growth was not unexpected as low base effects from the previous year continues to fade and the market normalizes towards long-term trend growth. Land sales and developers new housing starts (i.e. commencement of new construction projects) have also slowed, but this has been a result of the government’s deliberate tightening of policy conditions.
We believe that the slower growth that is now evident in the property market sales has not gone unnoticed by the Chinese government. In recent weeks, China’s central bank has made supportive comments about the property sector, while there has also been reports that banks in some cities may have started to ease their previous restrictions on mortgage loans. This has fueled hopes in the market that while the overall policy and credit conditions may remain tight, the government could further fine-tune their policy stance and allow for some marginal policy loosening in the sector. We also expect that there will likely be further clarity on the property sector after China’s Politburo meeting in November.
On the developers’ front, based on interim earnings results for 1H 2021, developers’ revenues have largely increased on a year-on-year basis due to higher bookings from prior years’ stronger contracted sales. Most developers also remain on track to achieve their FY2021 contracted sales targets. In addition, liquidity and gearing metrics are generally also improving for many developers as they seek to achieve compliance with the government’s ‘3 Red Line’ policy.
We maintain our constructive view on China’s property sector in the medium to long term. The property marketis still a large contributor to GDP growth and is an important cornerstone of China’s economy. Also,despite recent high-profile headlines for a select few developers, many developers in the USD bond market still maintain satisfactory credit fundamentals and adequate liquidity. In addition, we believe that the ongoing tightening policies for the China property sector will be beneficial in the long run as it helps to manage financial risks and promote a healthy and stable property sector in China.
Asian USD high yield bond valuations have widened beyond historical long-term averages
Recent events have led to some investors shying away from Asian high yield bonds. In fact, we do expect the China high yield property sector to continue to see more volatility over the short-term as market sentiments towards China developers in the USD bond market remains heavy.
On the other hand, for investors who have the risk tolerance to ride through short term market volatility, we believe that the Asian USD high yield offers room for capital appreciation over the next 12 months. We do see that the current bouts of market volatility are opportunities for investors to buy better quality credits with more resilient fundamentals.
From a valuation perspective, bond valuations in the Asian high yield have now pulled back to compelling levels, both on historical basis as well as relative to other high yield regions. On an absolute basis, Asian high yield credit spreads have widened beyond long-term averages to levels typically seen in past market crisis, like in 2020’s COVID-19 pandemic and in 2018’s US-China trade tensions. Based on past episodes of such heightened volatility, the market could subsequently see a strong rebound post the market event, as tighter credit spreads and high yield accrual help to deliver a strong performance for Asian high yield bonds.
Benefits of Asian USD high yield bonds in a rising rate environment
Historically, high yield bonds have generally been able to generate positive returns in a rising rate environment. This is in part thanks to the high yield buffer and short maturity profiles. High yield credit spreads also tend to stay supported amidst a positive economic expansion. At current valuations, Asian USD high yield bonds offer a high yield to maturity 8.6%1. Coupled with its’ short duration profile of 3 years1, there is value in adding Asian high yield bonds to a portfolio amidst an environment where US Treasury yields are expected to be on an upward trajectory. The shorter duration nature of Asian high yield will mitigate some of the impact of higher interest rates while the high yield buffer should compensate for the correction in Treasury yields.
Active management to manage risks
While the return potential for Asian high yield bonds are highly attractive, investors will need to be mindful of the idiosyncratic risks that is likely to persist in the near term. We believe that investors intending to allocate Asian high yield would benefit from an active management approach to this market. With a market value of about USD 274 billion1, the Asian USD high-yield market can be considered small relative to other high yield markets. There are also diversification and liquidity considerations in some market segments and issuers, which would require investors being nimble with single position sizing or staying with favoured credits that they would be comfortable to hold to maturity.
Asia, still one of the world’s fastest growing economic regions, with a vibrant bond market
With the world’s second largest economy China housed within its borders, Asia has become one of the fastest growing economic regions globally. Alongside Asia’s strong economic expansion, Asian USD-denominated bond markets have also grown exponentially at a rapid rate of over 15% annually over the last decade. With a market capitalisation of USD 1.26 trillion, Asian USD bonds is also a major driver of global EM bonds, makes up close to half of EM corporate bond market capitalisation.
Allianz Dynamic Asian High Yield Bond
Allianz Dynamic Asian High Yield Bond fund aims to capture attractive and consistent yield by primarily investing in high yield bonds in the Asian credit market. The strategy is managed with an active, conviction-driven investment style, with a target to deliver high yield income for clients. . Our strategy also incorporates the Allianz Global Investors’ approach to excluding from its’ investments, companies involved in Controversial Weapons and companies involved in Coal.
The key features of the Allianz Dynamic Asian High Yield Bond are:
All data references sourced from J.P. Morgan research, as at 30 September 2021.
Matthews Asia Funds - Asia Total Return Bond Fund
Teresa Kong, Portfolio Manager, Asia Total Return Bond Fund
Why do investors want to allocate to Asia bond?
We believe Asian bonds provide global investors with an important tool for building more resilient fixed income portfolios, while meeting long-term objectives by providing attractive returns and relatively low volatility. The Fund’s core philosophy is to capitalize on the best opportunities in Asia’s credit, currencies and interest rates while mitigating downside risk. It is driven by a fundamental, bottom-up investment process that is designed to avoid defaults and distressed sales. We draw on our investment team’s deep knowledge and expertise of the region and seek to identify mispriced securities, attractive risk-return profiles, and quality issuers with strong balance sheets and appropriate levels of leverage.
The growth of Asia’s bond markets is one of the region’s most important and remarkable economic developments of the last decade, fueled by a combination of domestic wealth generation and foreign investment, and we believe it is attractive from both a fundamental and valuation perspective. Following significant structural economic reforms that have taken place in the past decade, Asia’s sovereign credit ratings have been steadily upgraded by international rating agencies. Many emerging Asian nations now find themselves in stronger fiscal positions than many developed Western countries. In addition to enhanced credit quality, Asia’s bond markets have also experienced improvements in liquidity, transparency and diversification.
Is it a good time to invest now?
We believe now is a good time to consider investing in Asia bonds. Let’s look at the three components of returns: credit, currency and interest rates.
In terms of credit, the high yield or non-investment grade Asia credit spread is wide of its historical average and wide relative to other regions, including the United States and Latin America high yield.
In terms of currency, as global economies recover from COVID-19, global expansion and rising commodity prices should mean a weaker U.S. dollar and stronger Asia currencies. While a general recovery in risk sentiment helps all Asian currencies, we are mindful of idiosyncratic risks between each country with regards to the speed of each country’s recovery from COVID, ability to manage ongoing virus spread, as well as country-specific macro fundamentals. As such, the Matthews Asia Total Return portfolio is overweight to currencies of countries that we believe have greater capacity to manage Covid-19 and underweight to currencies of those that we think might struggle to contain Covid risk.
With respect to the interest rate component of returns, we expect investors to benefit from the Fed’s patient stance in interest rate hikes. While tapering is likely by the end of 2022, we expect any tapering to be relatively divorced from the path of interest rates and to have muted impacts on interest rates in the U.S. and globally. With the Fed potentially tapering, it may put pressure on Asian central banks to consider whether their policy is overly accommodative. Developed Asian rates are likely to follow U.S. Treasuries higher, but also lag in terms of the pace of rise. Overall, we expect interest rates to be a positive contributor to return, with its carry still outweighing that of price deprecation from mild rise of yields across most of Asia.
Where are you finding the most compelling investment opportunities?
We are finding opportunities in convertible bonds of sectors hit by new China regulations. While these companies’ equities and convertible bonds have gotten hammered, the underlying credit story is intact. In fact, some of the convertible bonds are yielding higher than that of a plain vanilla bond of a same or similar credit AND the upside optionality of the underlying equity. It’s difficult to get that kind of positive skew in a bond portfolio so these convertibles are attractive both from a return as well as diversification and skew perspective.
Sectors like internet, health care have not been traditionally large borrowers so they can add diversification. They may improve the sustainability of their business models by promoting healthy competition and improving consumer loyalty and sentiment. Over the long term, we believe regulations in these sectors will improve treatment of labor and consumer safety, and limiting monopoly-like practices may well be positive.
