Four reasons to favour Asian high yield

Given the volume of global bonds carrying low – or even negative – yields, Asian high yield debt has offered yield-hungry investors a route to returns that has been too meaningful to ignore. And it is a trend that still has some way to run.

The key for bondholders will be to adapt to an evolving market environment. As 2021 has progressed, for example, increasing rates volatility and emerging signs of uneven recovery across the region have raised some red flags. These were compounded by a surge in US yields in the first quarter.

However, various dynamics continue to justify a bullish view on certain parts of the Asian high yield landscape – assuming investors make well-thought out credit choices.

A route to resilience

Four key elements of the asset class will likely help it continue to contribute positively to portfolios for the foreseeable future:

  1. A supportive Asian growth story

    In general, the economic outlook for much of the region is promising. For example, the growth rate of the Asian economy overall in 2021 is expected to reach at least 6.5%, according to a report released by the Boao Forum for Asia in April1.

    Further, the region is forecast to account for just under 48% of the world's total GDP in 2021, up from roughly 45% in 2017. As a result, its importance as a driver of global growth is unlikely to diminish, especially given the rising value of global trade fuelling optimism. Part of the knock-on effect of this will be a boost for corporate earnings.
     
  2. A way to leverage opportunities in China

    As the world’s second-largest economy that has also rebounded quicker than most in the wake of the pandemic, China is an alluring prospect as part of any Asian high yield debt exposure.

    Notably, it saw a strong GDP growth in the first quarter of 2021. While there are some sceptics about China’s momentum as the world still grapples with the aftermath of Covid-19, proponents point to reforms led by Beijing – as part of the latest 14th Five-year Plan, released in March 2021 – to drive domestic consumption and growth of a higher quality than previously.

    In particular in the high yield space, the outlook for China’s property sector, which fuels a big chunk of overall regional activity, remains stable, according to Moody’s Investors Service. Despite tightening credit conditions onshore, the rating agency forecasts solid sales growth and continued access to financing for rated developers, both onshore and offshore2.
     
  3. An attractive alternative to global high yield

    Asia’s relatively reliable growth path has enabled it to deliver higher yields and returns than global peers. This is based on several key factors, including lower default rates historically compared with US high yield, higher average yields than most other type of global bonds, and a much shorter duration profile.

    As a result, Asian high yield debt is prone to a bigger source of potential income than equities during uncertain times. At the same time, while high yield corporates have experienced some deterioration in net leverage, liquidity levels are a beneficial offset and provide investors with comfort.
     
  4. A robust addition to a portfolio

    The resilience of Asian currencies during the pandemic against higher US yields offers another potential differentiator for regional high yield.  While Asian High Yield is predominantly USD based, local currencies have an indirect impact on regional high yield credits since conversion is required to service USD obligations.  Longer term this impact will be more direct as local currency high yielding issuance increases, which will provide further portfolio diversification opportunities.  In the current context, Asian currencies have shown resilience against the USD.

    For example, according to a report by Fitch Ratings, China' strong economic recovery has supported the Australian dollar and Korean won, while tailwinds for the Australian dollar and Indonesian rupiah, meanwhile, have come from high commodity prices3. At the same time, lower external imbalances in Indonesia and India have better supported the countries’ currencies during the recent episode of market volatility relative to the sell-off in 2013.

Getting choosy

Amid the changing investment landscape, one of the big stories in Asian credit in early 2021 has been the withdrawal of support and lack of transparency among some of China’s high-profile credit complexes.  Most recent and most prominent was the crisis surrounding China’s Huarong Asset Management.

As it became clear that this bad-debt asset manager has instead turned into a bad manager of debt, and subsequently left investor sentiment dented and wary, the government’s response proved it would no longer automatically back state-run entities in an effort to reduce so-called moral hazard (i.e., dependence of investors on government support) and improve the prospects of long-term quality growth.  While Huarong was an investment grade rated issuer as a result of a multi-notch uplift from all three major international rating agencies due to perceived systemic importance and implied government support, part of the company’s bond complex has been already downgraded to high yield and the rest may follow.  The implications of such rating actions go beyond Huarong as a large section of China’s investment grade rated bonds benefit from implied government support

This is posing somewhat of a challenge to the Asian high yield asset class as it begins to take on the added volatility and uncertainty of these actual and potential fallen angels. On the one hand, many relative value high yield plays are still in China, where volatility will likely remain. On the other, although opportunities to diversify outside of China are important, especially in sustainable new issues, the appeal of adding exposure to high quality, oversold Chinese issuers cannot be overlooked.

This highlights the increasing importance of focused analysis in finding mispriced credits. Yet effective bottom-up credit research is easier said than done.

Identifying financial flexibility should be a key goal for investors. More specifically, credits with high cash balances, access to bank lines and debt capacity at their rating level stand out, as do highly rated, defensive names, which can serve as good portfolio anchors.

Finding companies with an improving balance sheet trajectory, meanwhile, is also important. For example, issuers that apply leverage to grow and use cash flow improvements to pay off debt tend to get ratings upgrades agency and spread compression from the market. Such credits offer the opportunity for capital appreciation.

Investors should also look for companies with predictable operating performance, given that consistently high margins are preferable to low margin, cyclical issuers i.e., high financial risk can also be preferrable in some cases to business risk in terms of the source of portfolio carry.

Ultimately, the nature of Asian high yield securities requires an active, selective approach on several dynamics of an issuer.