Outlook 2021: Asian Credit - Riding the liquidity wave

Key points

  • Asian credit rebounded strongly since March 2020, but Asian High Yield has underperformed Investment Grade
  • As such, the spread level between Investment Grade and High Yield is still attractive
  • Despite ample global liquidity, COVID-19 has exposed credits with weak fundamentals. We expect greater credit differentiations going into 2021

Significant but uneven rebound since March 2020

Asian credit has rebounded significantly following the sell-off in March this year, underpinned by liquidity infusions by global central banks and the v-shaped recovery of  China’s economy. Most Asian countries have also contended with the pandemic relatively well. JACI (JP Morgan Asian Credit Index) has tightened almost 200bps from its peak in March through the end of November 2020, while total return has recovered from almost -5% to positive 5% in the same period.

It is interesting to note that the rebound has been highly uneven. Asian Investment Grade (IG) has outperformed High Yield (HY) with no surprise given the significant rally in US treasury rates. More importantly, the rebound within the high yield universe has been uneven. While BB-rated credits returned 4.8% year-to-date B-rated credits have only marginally turned positive (0.4%). As such, the spread between BB and B is currently still at 480bps, much higher thanits 5-year average of mid-200bps.1 During 2020, China High Yield credits have also significantly outperformed the rest of Asia, but the trend has started to reverse since 3Q20.

Macro and Valuation remain supportive

Going into 2021, we think the macro backdrop remains supportive for Asian credits. One of the key drivers for Asian credit spreads to tighten further from current levels is the continued search for yield by global investors, which is becoming more challenging. Negative yielding bonds have risen to $16.5trn globally, accounting for a quarter of the global fixed income market. The share has risen to over 35% within the government bond universe.2 Given that Asian credits were able to demonstrate relative resilience during COVID-19  - underpinned by higher average ratings, a strong local investor base and lower exposure to commodities - the asset class should continue to benefit from global inflows as  markets rotate from low yielding bonds into income-generating assets. In terms of valuations, the pick-up of over 160bps between Asian and US BB-rated credits remains at the wide end of historical averages. It is even wider in the single B space with a pick up of over 400 bps. (Exhibit 1) As such, we have seen consistent inflows of US$ 1-2bn on a monthly basis into Asian fixed income since April 2020.3

On the other hand, trade tensions between US and China could continue to be an overhang/ distraction going into 2021 as more China State-owned entities (SOE) are being put on  US sanctions lists. However, the fundamental impact of these sanctions has so far been manageable given that these SOEs do not appear to be reliant on US access in either sales or funding. It is important to note that the onshore China bond market is over 10 times (US$14trillion) bigger than the offshore Asian bond market (US$ 1trillion) and serves as key funding channels for China SOEs.

2021’s key drivers: High Yield looks attractive

For Asian credits, in the near term we can resume a regional focus where a positive risk sentiment and risk to the upside for US Treasuries suggest adding high yield credit, the recent weakness of which offers some relative value. We look to remain short/underweight duration, and incrementally add unhedged local currency exposure (rates and/or credit). 

Following Asian High Yield’s underperformance in 2020, the subsector currently offers a spread pick-up of over 400bps compared to Asian Investment Grade. In particular, single-B credits are still trading 300bps higher than pre-COVID-19 levels and 500bps over BB credits. With ample global liquidity, we view that the spread difference between HY vs. IG and B vs. BB will have plenty of room to compress further from current levels

Forward-looking Positioning: Greater Credit Differentiations

Going into 2021, although we have a preference for Asian High Yield and single-B credits, we note that the pandemic has exposed weaker credits and resulted in greater credit differentiation. Despite ample liquidity in the banking system and bond markets, investors and banks have taken a cautious approach and become even more selective. As seen in the recent defaults in China’s onshore market, the country’s SOEs were not spared. So, potential government support for zombie SOE companies in non-strategic sectors should not be taken for granted. 

Given the greater differentiation within the High Yield and single-B space, we will position in favour of issuers with  decent operating scale and high quality assets (e.g., selective Chinese property developers), stable revenue and solid cash flow generation (e.g., Indian renewable credits), ample liquidity buffer (e.g., Macau gaming credits) and reasonable banking relationships (e.g., selective Indonesian property developers with strong shareholders). We also favor sectors that are least impacted by the pandemic, including the Telecom sector. We also think commodity-related issuers are well-positioned for a turnaround story from COVID-19 and strong economic recovery in China. Meanwhile, we will continue to avoid issuers with limited funding channels, looming maturity walls, and who operate in sectors with structural downward trends(e.g., retail and coal mining). 

With a focus on stable returns, in the short duration space we will emphasize carry and low volatility, and favour issuers with strong ESG features, an area we expect to grow strongly in 2021.       

For the high yield subsector, factoring in expectations of higher yields and total returns for greater implied risks, we will emphasize spread compression opportunities to enhance total returns as default risk may be overstated in some issuers’ credit spreads.

Sources:

[1] Source: Bloomberg, as of end of November 2020

[2] Source: JP Morgan, as of end of Oct 2020

[3] Source: JP Morgan, as of end of Oct 2020