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Asia high yield strategy: A total return approach in a hunt-for-yield environment

Alfred Mui, Head of Asian Credit, discusses the reasons behind the appeal of Asian high yield bonds as well as the opportunities and outlook of the HSBC Asian high yield strategy.
19 November 2019
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    Key takeaways

    • Negative yielding debt now makes up about 24 per cent of global investment grade bonds, prompting investors to seek higher yielding assets. Asian credit is expected to benefit from the global hunt-for yield given its yield advantage and diversification benefits
    • Monetary easing bias and decline in rates globally have provided a more supportive backdrop for funding for Asian corporates and have helped to reduce refinancing risk. We have seen a big downward adjustment in the 2019 forecast for Asian high yield default rate, now expected at 1.5 per cent (vs. 2.5 per cent previously)
    • The valuation narrative for Asian high yield continues to be compelling. Asian high yield corporates are yielding 7.4 per cent, versus 6.4 per cent for US high yield and 3.7 per cent for Euro high yield
    • Investing in Asian high yield bonds has the potential to improve returns and even lower the volatility of a global high yield portfolio: over the last five years, Asian high yield outperformed global high yield and has done so with lower volatility
    • The HSBC Asian high yield strategy has been able to navigate both risk-off and risk-on market scenarios. Credit selection has been critical to our performance and our strong credit research has helped us avoid poorly performing names

    What are the implications of dovish central bank policies on Asian high yield bonds?

    Global monetary easing continued in the fourth quarter of 2019, with the US Federal Reserve cutting the fed funds rate to a target range of 1.50 percent-1.75 per cent in October. This was the third consecutive rate cut this year and acts as insurance against downside risks. While the Fed’s stance remained accommodative, it did signal a pause in rate cuts. The European Central Bank (ECB) has also restarted quantitative easing (QE) in November in an attempt to address economic slowdown. With the US Fed easing, central banks in Asia are allowed more room to continue their expansionary monetary policies. Central banks across major Asian economies have eased in 2019 as the growth outlook softens and inflation trajectory remains benign.

    Dovish monetary policies have acted as major drivers of the global bond rally in 2019. Year-to-date, global bonds (USD hedged) have returned 8.1 per cent, US investment grade and high yield bonds are up 12.4 per cent and 12.0 per cent, and Asia USD investment grade and high yield bonds are up 9.0 per cent and 11.6 per cent respectively.1

    The current market environment of global economic slowdown and monetary policy easing bias have resulted in a general shift downwards in bond yields. Negative yielding debt is now making up about 24 per cent of global investment grade debt, which is prompting investors to seek higher yielding assets. One of the beneficiaries of the global hunt for yield has been emerging market hard currency debt, which has seen strong fund inflows year-to-date of USD51 billion, as opposed to the USD9 billion in 2018. The largest issuer within emerging markets – Asia – is benefiting from the constructive emerging market flows. The low to negative yielding environment is lifting the appeal of Asian high yield given its yield advantage and diversification benefits.

    Fig. 1: Sharp jump in global negative yielding bonds

    Percentage of outstanding bonds with negative yields in Bloomberg Barclays Global Aggregate index

    Sharp jump in global negative yielding bonds

    Source: Bloomberg, as of October 2019.

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    Asian credit is also increasingly being viewed as higher quality assets within emerging markets. Since 2017, Indonesia has seen three upgrades in its sovereign credit ratings (two from S and P and one from Moody’s), while both India and the Philippines have been upgraded in the last two years. These three markets all hold investment grade credit rating, and the recent upgrades have helped to further solidify the appeal of these markets. Asian credit offers global investors the opportunity to invest in higher quality credits, as compared to non-Asia emerging markets; at the same time, yields remain compelling. As a result, Asian credit in general is attracting more developed market investment grade focused investors, thus bringing in a new force of buyers.

    Meanwhile, local investor demand for Asian high yield continues to be strong. Investor interest from China remains healthy, supported by the improving liquidity situation in onshore China as well as Chinese investors’ desire to diversify and seek assets that provide a yield pickup.

    Fig. 2: Asian markets: Sovereign credit rating upgrades in recent years

    Asian markets: Sovereign credit rating upgrades in recent years

    Source: Bloomberg as of November 2019

    We have also seen lower refinancing risk for Asian corporates given the decline in rates globally and the more supportive backdrop for funding. There has been a big downward adjustment in the 2019 forecast for Asian high yield default rate, now expected at 1.5 per cent (from 2.5 per cent previously).

    Additionally, the downward shift in rates has led to more longer dated new issuance from Asian high yield corporates. This is beneficial as it can help term out maturities and in effect lower refinancing risk in the market.

    Overall, the Asian high yield market should continue to benefit from lower rates – which have prompted the global hunt for yield, constructive flows into emerging market and Asian credit, and a more supportive funding environment.

    1Source: Bloomberg, JP Morgan, as of 7 November 2019

    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.

    Given the rally this year, are valuations still attractive?

    The valuation narrative for Asian high yield continues to be compelling. On a relative basis, the Asian high yield market is trading at attractive spread levels, offering a spread pickup over US peers and emerging market peers (See Figure 3).

    There is also a steep spread differential of around 530bp between high yield and investment grade within the Asian credit market. By way of comparison, the spread differential in the US credit market is only 270bp, which further points to the attractiveness of Asian high yield.

    Fig. 3: Asian high yield corporate bonds: Yield advantage

    Asian high yield corporate bonds: Yield advantage

    Source: JP Morgan, BAML, as of 30 October 2019.

    How do you see the issue of rising defaults in China impacting the Asian high yield strategy?

    While there has been an increase in onshore China defaults this year, it is important to note that defaults are occurring mostly in private bonds, which is only a small subset of the market. Given the relatively small size and the limited investor participation of China’s private bonds (that have been defaulting), the defaults are not expected to trigger systemic risk. Onshore China bond defaults may cause volatility in the offshore market, but China’s policies are expected to provide adequate liquidity in the onshore market, ensuring effective liquidity transmission to the private sector.

    Our credit selection process enables us to focus on credit fundamentals in order to see through market noise, identify mispricing opportunities and, most importantly, avoid investments with potential default situations.

    What are your investment views on the property sector in China?

    For offshore China high yield property bonds, credit fundamentals remain intact amid solid sales growth and high levels of cash raised for refinancing (see Fig. 4). For the HSBC Asian high yield strategy, we prefer large property players. We believe established developers would be able to increase land purchases through direct negotiation with local government units or acquire assets from other counterparts. Industry consolidation is expected to continue and this should ultimately benefit established players.

    We see good value in B-rated property developers as this is the steepest part of the credit curve; we see them as having improving fundamentals, manageable refinancing risk and limited supply in the near term.

    Fig. 4: Improving fundamentals for China property issuers

    Improving fundamentals for China property issuers

    Source: JP Morgan as of October 2019.

    Do you have concerns surrounding geopolitical uncertainties, including US-China trade tensions, and the more challenging macro environment?

    The direct impact of US-China trade tensions on Asian credit is limited, although we recognize the situation can have an indirect impact on the market. Trade tensions may dampen risk sentiment, but we believe that this also increases the appeal of Asian credit, given the region’s solid macro and corporate fundamentals.

    Further, there are areas in the Asian high yield universe that would likely benefit from potential trade diversion, including markets of Indonesia and Vietnam. There are also attractive opportunities in India high yield bonds, including in the materials and renewable energy sectors, which have very low correlation with developments in US-China trade tensions. Despite the economic slowdown, fundamentals of Asian high yield issuers are staying intact as revealed by 1H2019 credit metrics. Over the years since 2016, fundamentals of Asian high yield corporates have been on an improving trend, with leverage coming down and liquidity remaining adequate. These credit metrics continue to trend up even in 1H2019. Solid fundamentals indicate that a lot of the Asian high yield issuers are more equipped to weather uncertainties in the investment environment.

    How has Asian high yield as an asset class performed against other high yield markets?

    In the context of emerging markets, Asian high yield bonds are relatively less vulnerable to movements in emerging market sentiment. In fact, over the last five years, Asian high yield corporates were found to be less volatile than emerging market high yield corporates; over many periods, Asian high yield has also exhibited lower volatility than US high yield and Euro high yield.

    There are several reasons that can help explain Asian high yield’s relatively lower volatility. One factor is Asian high yield’s relatively lower duration when compared to peers, which generally results in lower sensitivity to interest rate movements and thus lower volatility.

    Additionally, Asian high yield has a strong local investor base, which helps reduce vulnerability to emerging market sentiment. In 2019, 86 per cent of Asian high yield new issues have been allocated Asian investors.2 Chinese investors in particular have been active in taking up new issues in Asia.

    Fig. 5: Asian high yield has exhibited generally lower volatility than EM and US peers over the last 5 years

    Standard deviation (12-month rolling) annualised

    Asian high yield has exhibited generally lower volatility than EM and US peers over the last 5 years

    Source: Bloomberg, JP Morgan as of 31 October 2019.

    It is also notable that Asian sovereigns have higher credit ratings when compared to non-Asian emerging markets. Singapore and Hong Kong are rated AAA and AA+ respectively (by S&P), while Korea is becoming more recognized by investors as a developed market. India, Indonesia and the Philippines, while considered developing markets, have seen a number of upgrades in their sovereign ratings in the recent years, reflecting improvements in their fiscal and monetary stability and other external metrics.

    Over the last five years, global high yield (hedged to USD) has returned 5.5 per cent on an annualised basis with an annualised volatility of 3.3 per cent. Asian USD high yield, on the other hand, has outperformed global high yield and returned 5.9 per cent on an annualised basis, with a lower annualised volatility of 2.6 per cent. Using a simple analysis of adding 20 per cent of Asian high yield exposure to a global high yield portfolio, we find that annualised returns would have increased by 9bp. Meanwhile annualised volatility would have been lowered by 36bp. As a result, the risk adjusted returns of a global high yield portfolio, with 20 per cent Asian high yield, would have improved. This analysis shows that investing in Asian high yield bonds has the potential to improve returns and even lower the volatility of a global high yield portfolio.

    Fig. 6: Return and volatility comparison

    Return and volatility comparison

    Fig. 7: A mix of 80 per cent global high yield and 20 per cent Asian high yield

    A mix of 80% global high yield and 20 per cent Asian high yield

    Source: JP Morgan, BAML, as of 30 October 2019. Based on the 5-year period ending 31 October 2019. Based on the assumption of no transaction costs and portfolio rebalancing. Investment involves risks. Past performance is not indicative of future performance. Hypothetical analysis is for information purpose only and should not be relied on as indication for future result.

    2 Source: Bloomberg, as of October 2019

    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.

    Asian high yield investment opportunities and outlook

    We take a total return approach when investing in Asian high yield bonds. We prefer the short end of the curve while remaining selective in the long end. In China, we like select high yield property names, preferring large players; fundamentals for the sector remain intact, and we believe certain robust names could outperform on the back of improved cash collection and reduced land banking. The government also continues to have strong incentives to maintain a stable property market to help keep growth in check. In Indonesia, we continue to favour select names in the utilities and property sectors as their yields are attractive and fundamentals remain sound. In India, we like select names in the renewables sector and stable short dated industrial names. Elsewhere, exposure to emerging market sovereigns could benefit from potential trade diversion; in addition, we like taking exposure to local currency bonds on a hedged basis to ride on the easing rate trend within the regional markets. We continue to explore high-yield-like securities issued by stable investment grade names, including bank subordinated debt.

    Contribution to return in credit markets in 2019 has largely been from term premium of US Treasuries resulting from monetary easing around the globe. Credit spread compression, on the other hand, has not fully played out yet. Given recession risk is moving further away from us at least in the near term, credit valuations have not priced in growth recovery, which suggests that credit markets can see spreads tighten. Under such a scenario, Asian high yield bonds are well positioned given their wider spread pickup against global peers as well as improving technical dynamics and fundamentals.

    HSBC Asian high yield strategy

    Credit selection in our Asian high yield strategy continues to be critical and our strong credit research has helped us avoid poorly performing names. Defaults are continuing in the Asian high yield space, although we believe that defaults are manageable and do not point to a systemic crisis. Still, staying prudent and vigilant in our strategy and focusing on relative value opportunities are important in this market environment.

    The fixed income markets have undergone both risk-off scenarios as well as a risk-on scenarios in 2018 and 2019. These periods therefore showcase our ability to navigate both the up and down cycles of the market. Our approach of focusing on better quality non-investment grade bonds benefitted us in risk-off sentiment scenario of 2018. In this current market environment, our exposure to emerging market sovereigns, for instance, has benefited us in a market where emerging market flows have been constructive; this provides our strategy with duration exposure and an additional source of alpha.

    Our ability to produce diversified sources of alpha including from our duration strategy, curve positioning and currency exposure, ultimately contributes to optimal capital appreciation potential for the HSBC Asian high yield strategy.

    Important information

    The value of investments and the income from them can go down as well as up and investors may not get back the amount originally invested. Past performance contained in this document is not a reliable indicator of future performance whilst any forecasts, projections and simulations contained herein should not be relied upon as an indication of future results. Where overseas investments are held the rate of currency exchange may cause the value of such investments to go down as well as up. Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in some established markets. Economies in Emerging Markets generally are heavily dependent upon international trade and, accordingly, have been and may continue to be affected adversely by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. These economies also have been and may continue to be affected adversely by economic conditions in the countries in which they trade. Mutual fund investments are subject to market risks, read all scheme related documents carefully.

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