Asia credit in the Year of the Ox
- An economic backdrop of recovery in Asia and the continued accommodative bias from central banks globally should provide support for Asia credit in the coming year
- Asian corporates had solid fundamentals heading into 2020 which helped them stay resilient when the pandemic hit. In 2021, default rates are expected to be lower than 2020
- Asia credit trades at a yield premium over US credit and even emerging market USD bonds, pointing to the attractive valuations of Asia credit relative to other markets
- While there is some spillover effect of the default development in the onshore China bond market to the offshore China USD credit market, it has been limited and has also led to greater pricing differentiation, and our investment process is well suited to navigate such a landscape
Ushering in the Year of the Ox
The disaster that is the coronavirus pandemic surely wreaked havoc in the global economy during the Year of the Rat and continues to bring pain to the lives of people around the world. As we now usher in the Year of the Ox set to commence on 12 February, what can Asia credit investors leave behind and what is expected ahead?
Economic recovery in Asia is underway, and 2021 is expected to be a year during which activities transition to a post-Covid new normal. Manufacturing production has already returned to pre-Covid levels in many Asian economies and goods consumption is also rebounding. In 2020, North Asia’s economic growth outperformed the rest of the region (and the world), while in 2021, there is a larger scope of catchup growth for India and ASEAN. There are near term risks due to resurgence of infections, but we do not expect a significant derailing or reversal of the recovery. The higher level of healthcare policy and institutional preparedness, a more targeted and less stringent containment approach, and an increased adaptability by consumers and companies to the new normal would all help act as mitigating factors to any negative impact. The availability of effective vaccines is also a positive for a rebound in activity.
Despite the pandemic, global capital markets enjoyed good performance overall in 2020, largely thanks to the coordinated support from central banks globally. In 2021, and likely through 2022, the US Federal Reserve is expected to keep rates at zero and repeated its pledge in January to keep an accommodative monetary policy stance until the economy achieves maximum employment and moderately above target inflation. Monetary policy in Asia should also remain accommodative; in spite of the relatively hawkish policy tone in mainland China and the potential for policy normalisation in select Asian economies in the second half of 2021, an abrupt exit of policy support is unlikely.
An economic backdrop of recovery in Asia and the US Fed’s commitment to keep rates low should continue to provide support for Asia credit in the coming year. The certainty around interest rates should also allow for volatility to stay in check in 2021.
Fig. 1: Performance of USD bond markets
Total return performance (31 Dec 2019=100)
Source: Bloomberg, BAML, JP Morgan as of 25 January 2021.(3)
Investment involves risks. Past performance is not indicative of future performance.
Fallen angel risk and default outlook
The pace of credit rating downgrades in Asia credit has slowed down when compared to the period immediately following the sharp sell-off seen in March and April of 2020. The third quarter of 2020 saw a significant improvement in the rating action and this is expected to continue.
Globally, concerns around fallen angel risk in bonds have not dissipated. Fallen angels refer to bonds with a newly acquired high yield status, having been cast out of the investment grade realm following a ratings downgrade. In the first nine months of 2020, around USD 5.2 billion of Asia investment grade credit was downgraded to high yield, which amounts to 1.4 per cent of the Asia investment grade credit universe – a rate which is only a little higher than the 1.2 per cent historical average(1). The low fallen angel risk for Asia is partly a reflection of the structure of the market – such as having a relatively small sized BBB-rated cohort when compared to the US or Europe – as well as the strong and stable credit profile of Asia investment grade companies. There is a downgrade risk for the sovereign credit rating of India given the negative outlook held by Fitch and Moody’s; in a downside case scenario where we factor in a sovereign rating downgrade into our analysis, a larger amount of investment grade bonds would be downgraded to high yield, but the situation under this scenario would still be manageable. Overall, we continue to expect strong rating stability in the Asia credit BBB universe and low fallen angel risk.
The high yield default rate in 2020 for Asia was 3.4 per cent, versus 3.5 per cent for emerging markets, and 6.8 per cent for US high yield.(2) Asian corporates headed into 2020 with solid credit fundamentals, which helped them stay resilient when the pandemic hit; heavy issuance in the prior year was also helpful in lowering refinancing risks in 2020. In 2021, default rates are expected to come down for Asia credit, as well as for emerging markets and US credit.
Fig. 2: High yield default rates expected to come down
High yield default rates
Source: JP Morgan, January 2021. Default rates for Asia and EM (total) were sourced from JP Morgan’s EM Corporate Default Monitor report dated 6 January 2021. Default rates for the US were sourced from JP Morgan’s Default Monitor report (Figure 5) dated 4 January 2021. Any forecast, projection or target contained in this presentation is for information purposes only and is not guaranteed in any way. For illustrative purpose only.
Valuations following a turbulent year
On a relative basis, Asia credit trades at a yield premium over US credit and even emerging market USD bonds, pointing to the attractive valuations of Asia credit relative to other markets.
Fig. 3: Yield comparison
Yield to maturity (per cent)
Euro yields are hedged to USD. Source: JP Morgan, BAML, Bloomberg as of 25 January 2021.(3) Investment involves risks. Past performance is not indicative of future performance.
Asia credit valuations are also reasonable when looked at on a historical basis. Current spread levels are still wider than historical levels and also wider versus pre-Covid levels. For the Asia high yield market, the year of 2020 started out with spread levels at around 500bp, and at the height of the Covid-induced market panic in March of 2020, spreads had reached the 1100bp level; currently Asia high yield bonds are trading at around 580bp, still wider than at the beginning of 2020.
Asia high yield should have room for spread tightening – Asia high yield is trading at a steep spread differential of around 600bp over Asia investment grade bonds. By way of comparison, the spread differential in the US credit market between high yield and investment grade bonds is only 280bp.
Fig. 4: Attractive spread levels for Asia high yield
Source: Bloomberg, BAML, JP Morgan as of 25 January 2021.(3)Investment involves risks. Past performance is not indicative of future performance.
Technicals to remain supportive
2020 saw a record amount of gross supply in Asia credit, and 2021 is expected to see supply stay at high levels.Net financing in 2021 is expected to be slightly below 2020’s figure, and is likely to be driven by supply from the investment grade market. A large amount of the supply in 2021 is expected to be used for refinancing
Meanwhile, local investor demand for Asia credit continues to be well supported, and Asian investors still make up the largest investor base of new issue allocation; however 2020 saw an increase in demand from investors based in US and Europe. The Asia credit market should continue to attract foreign funds and benefit from ample global liquidity and the global search for yield.
This year’s cyclical and commodity recovery outlook has the potential of benefiting emerging market assets. Asia is set to benefit from constructive emerging market fund flows being that Asia makes up a large segment of the group and that it is supported by strong recovery momentum and overall solid macro picture.
US-China trade tensions are expected to be extended even under a new US administration. Late last year, an executive order issued by the former US president prohibits US citizens and legal entities from transacting in a list of alleged military backed Chinese companies. Whilst the executive order has led to some forced selling by passive and active funds in the near term, the impact is more around trading and liquidity rather than on credit fundamentals. Meanwhile, these technical drivers may prove temporary, whether or not the executive order is maintained.
Another key risk highlighted by investors is that of defaults in the China onshore bond market impacting the offshore China USD credit market. The onshore default events have included the largest state owned enterprise default and the first ever LGFV (local government financing vehicle) default. We believe that this situation represents a continuation of the credit clean up trend over the last few years and that the government is taking advantage of the strong economic recovery to reinforce market discipline. While there is some spillover effect to the offshore China USD credit market, it has been limited and has also led to greater pricing differentiation between issuers with sound underlying credit fundamentals and those simply relying on state support. We believe this is a helpful development for the market overall and that our investment process is well suited to navigate such a landscape.
Update on mainland China property
Following a strong 2020 in terms of bond performance and sector recovery, we remain constructive on the mainland China property sector despite the recent market volatility that was driven by a handful of debt heavy names. Although mainland China’s “three red lines” policy to curb leverage could bring about a growth slowdown in the sector, the goal of the government is to avoid over-heating the housing and land markets. We expect refinancing to remain largely sustainable given the active liquidity support provided by the PBoC to alleviate funding stress. Over the short term, we may see greater credit differentiation in the market where highly leveraged property developers may underperform given their constraints on using debt as a means for growth. Nonetheless, technicals for the mainland China property sector are favourable in 2021 since many developers have pre-funded their maturities in 2020. Despite these tightening measures and some negative headlines, the overall sector remains well supported by strong investor demand, particularly in an environment of low global yields and economic recovery.
Looking ahead, we continue to expect greater credit divergence. We maintain our preference for developers with high-quality land bank, strong sales execution and solid onshore funding sources; we believe these types of developers can better weather the regulatory tightening and should also be able to benefit from the accelerated sector consolidation.
Latest sector views
In our Asia credit strategy, we continue to like bank subordinated debt given their relatively defensive nature and attractive yields. We have an overweight preference for the mainland China property sector, although more on an individual bond selection basis. In India, we are overweight the utilities sector, favouring names with greater earnings stability. One of our preferred sectors in Indonesia is oil and gas given the cyclical and commodity recovery; elsewhere in Indonesia, we like quasi-sovereign names with a good yield pickup over sovereigns. We are also looking at sectors and names that have been oversold but where fundamentals remain solid. We believe funding channels for select names may open up this year, especially in the Southeast Asia region.
Credit selection in our Asia credit strategy continues to be critical and our strong credit research has helped us avoid poorly performing names. Our performance during the Covid-19 crisis – as well as during the various risk-off and risk-on scenarios over the past 25 years – showcase our continued ability to generate risk controlled alpha regardless of the market cycle.
2020 was a year of unprecedented challenges for the global economy, markets and society. But it was also another year of important development in Asian bond markets, with greater investment from outside Asia than we have ever seen before. The traditional arguments for including Asia credit as a strategic allocation in global portfolios, including higher yields and diversification, were perhaps more urgent than ever with even lower levels of global interest rates and heightened credit risk. Importantly, the Asia credit market did not buckle under the strain of some of the most severe economic headwinds in history. On the contrary, the asset class performed well and did indeed provide that valuable risk diversification global investors seek. Going into 2021, risks remain acute throughout global markets, but we believe that Asia credit will once again prove to be a long term value proposition providing steady and competitive returns.
Source: HSBC Global Asset Management, JP Morgan, Bloomberg, BAML as of January 2021. Note 1: Source is JP Morgan report “Asia Credit Outlook and Strategy, The Year of a Battle-Hardened Bull, January 2021”; Note 2: See Figure 2 and the corresponding source. Note 3: Indices used: US IG Corp – ICE BofA US Corporate Index; US HY Corporate – ICE Bofa US High Yield Index; Euro IG Corp – ICE BofA Euro Corporate Index; Euro HY Corp – ICE BofA Euro High Yield Index; Asia IG Corp – JP Morgan Asia Credit Corporate Index Investment Grade; Asia HY Corporate – JP Morgan Asia Credit Corporate Index Noninvestment Grade, spread to worst used for Fig. 4; EM IG Corp – JP Morgan Corporate Emerging Market Bond Index (“CEMBI”) Broad Diversified Index High Grade Blended Yield (Fig. 3) and JP Morgan CEMBI Diversified High Grade Index Level (Fig. 1); EM HY Corp – JP Morgan CEMBI Broad Diversified Index High Yield Blended Yield (Fig. 3) and JP Morgan CEMBI Diversified High Yield Spread to Worst (Fig. 4) and JP Morgan CEMBI Diversified High Yield Index Level (Fig. 1)
Investment involves risks. Past performance is not indicative of future performance. Any forecast, projection or target contained in this presentation is for information purposes only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecasts, projections or targets. For illustrative purposes only.
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