The Asian high yield bond segment has had a happening year in 2021. Amid the recent series of selloffs, the credit segment now promises an alluring yield-to-worst of 8.8% – a proposition almost ‘too good to be true’ in this yield-starved backdrop. Are Asia HY bonds a value pick or a value ‘trap’? We delve deeper to find out more.
Ong Zi Yang | Published on 20 Aug 2021
- Bonds of China real estate developers, especially Evergrande, were sold off heavily on concerns over credit stress. The sell-off implicated the performance of Asian High yield (HY) credits, which recorded a -1.9% decline YTD – one of the worst-performing credit segments in 2021 so far.
- While Asian HY credits seem priced for further negative development, China’s credit situation is starting to show signs of Improvement – namely, the Huarong crisis averted and Evergrande’s debt-reduction program.
- Three reasons why Asia HY bonds are worth investing now – (i) highest yields in the bond market today; (ii) attractive valuations, both historically and relative to peers; and (iii) resiliency to Interest Rate changes.
- For exposure to the Asian HY sector, investors can consider adding to our recommended Asian High Yield bond fund, the Eastspring Investments – Asian High Yield Bond ASDM SGD-H.
- While the fund’s overweight on China’s high yield real estate sector has contributed to its recent underperformance, it is well-positioned for a recovery play in the Asian HY/China real estate sector, particularly as credit concerns start to wane.
Asian high yield bonds need no introduction this year. This highest-yielding credit segment within Fixed Income space was featured rather regularly on the headlines in recent months, albeit for the wrong reasons.
Starting with the China Huarong credit crisis earlier this year, to the more recent China Evergrande Group’s debt risks, these seemingly ‘too big to fail’ conglomerates suddenly find themselves on the knife’s edge – as Chinese policymakers marched ceaselessly ahead with their deleveraging drive.
What’s happening in the Asian High Yield space?
In the latest episode surrounding China’s 2nd largest property developer, Evergrande was in the crosshair of Chinese regulators over its massive, allegedly unsustainable debt levels. Triggered by the freezing of some of Evergrande’s bank deposits, the group’s shares and bonds were heavily sold off by anxious investors.
The subsequent selloff dragged on overall market sentiment, as the exposé stoked concerns that the developer is likely not alone in its toxic debt levels. Emotions were running high that a collapse of such a systemically important real estate giant could have a Contagion effect on the entire sector – a cascade of defaults among smaller developers with weaker credits, which could then potentially culminate into a full-blown credit crunch within China.
In a short span of 3 months, the price of the Evergrande 2022 USD bond plummeted by more than 50% (and is currently trading at a historic low price of USD 47.0), alongside that of peers in China’s real estate sector as investors took flight. Apart from China real estate, weakness also materialized in Indonesia and India high yield credits as Delta variant and growth concerns weighed on the markets.
Unsurprisingly, the scandal-plagued Asian High Yield (HY) bonds ended up as one of the worst-performing credit segments in 2021 so far. Asian HY bonds recorded a -1.9% decline (in USD terms) YTD, in a backdrop where high yield bonds (i.e. US and Europe) are supposedly key beneficiaries of investors’ reach for yields (Chart 1).
Chart 1: Asian HY bonds shrunk by -1.9% to date – a stark contrast to the robust performance seen in its US and Europe counterparts.
What to expect for Asian HY ahead?
For starters, investors seem to expect the onslaught of negative development on Asian HY credits to continue – or at least they are pricing in the scenario as such. Credit spreads for Asian HY corporate bonds have widened significantly in the last 3 months – breaking past the key psychological OAS* threshold of 8%.
*Option adjusted spread (OAS): An OAS measures the difference in yield between a bond and Treasury yields. Generally, investors can consider OAS as sort of a risk premium – additional yield for taking on credit risk.
Indeed, such expectations are reasonable. China regulators have made reducing debt, via a nationwide deleveraging drive, a key policy priority. They have repeatedly flagged out in recent years the ballooning corporate borrowing levels as a ticking bomb within its economy.
At the same time, policymakers are increasingly focused on tackling the rising cost of living in China and the societal impacts it entailed. This was also the main motivation behind the recent crackdown on the for-profit after-school tutoring industry (which has added to the pessimism surrounding Chinese assets).
To rein in rising property prices, regulators have turned to pressuring developers – Evergrande the most prominent amongst them – through both political and financial means. Eventually, this lethal combination of credit tightening, financial deleveraging, and a decline in liquidity, brought Evergrande to its knees.
The exposé on Evergrande, however, has also opened the proverbial ‘can of worms’, and debt risks across China have begun to surface (esp. zombie enterprises). Recent defaults by developers Sichuan Languang and China Fortune Land also served to confirm investors’ fears. Consequently, credit ratings of various developers were quickly downgraded and expected default rates surged.
What’s more worrying, however, is China government’s attitude towards the rising default rates –they appear to be quite comfortable with it. This is most evident in the well-publicised credit stress on China Huarong Asset Management – a state-owned enterprise (SOE) deemed “too big to fail”. Despite the obvious systemic risks that a collapse of such an entity would impose on its financial system, China policymakers were hesitant to bail it out. Investors were rightfully concerned – if a systemic, state-owned entity couldn’t, then the odds are likely even lower for a bailout in the private sectors.
Not All’s Bad – China’s credit situation starting to show signs of improvement
While the overhang of credit deterioration and liquidity concerns on Asian HY bonds could persist in the short term, the outlook is starting to look brighter ahead.
Firstly, the China Huarong credit crisis has finally come to an end – policymakers have decided to bail Huarong out with a recapitalisation plan by state-backed investors. Investors cheered on the good news with a robust rally on Huarong bonds; at the very least, this marks one less thing for Asian bond investors to worry about.
Secondly, China appears open to easing the throttle on its deleveraging drive. In July, the People’s Bank of China (PBOC) cut the reserve requirement ratio (RRR) – the amount of cash most banks must hold in reserve – by 50 bps, which should ease some liquidity pressure on credit issuers. Policymakers have also signalled greater fiscal support for the economy, during a quarterly meeting last month.
Fundamentally, despite the current pessimism around the China real estate sector, a vast majority of developers (>80%) are still within the safe confines of the “Three Red-Lines” guided by Chinese policymakers.
Ultimately, we are also hopeful that Evergrande’s debt-reduction program could likely succeed – there are multiple ways they can ease liquidity pressure (e.g. asset sales, repaying debts using sales cash inflows). Our bond analyst has covered the recent Evergrande’s debt crisis extensively, and interested investors can read his latest article in the link below.
Three Reasons Why Asian High Yield bonds are worth a closer look now
Nonetheless, the recent sell-off in Asia high yield (HY) bonds should also pique the interest of value-oriented investors. Indeed, the credit segment now promises an alluring yield-to-worst of 8.8% – a proposition almost ‘too good to be true’ in this yield-starved backdrop.
Here are 3 reasons why Asian HY bonds are worth a closer look at this juncture:
1. Asian HY Bonds offers one of the highest yields anywhere in the bond market today
Table 1: Yield-to-worst offered by the various global credit segments
|Bond Segment||Yield-to-worst (%)|
|Asian High Yield Bonds||8.83|
|Global High Yield Bonds||4.50|
|US Corporate High Yield Bonds||4.11|
|Europe Corporate High Yield Bonds||3.12|
|Asian Investment Grade Bonds||2.13|
|Global Investment Grade Bonds||1.01|
|Source: Bloomberg Finance L.P., iFAST compilations; data as of 18 August 2021|
With interest rates still near historical lows, investors have been hard-pressed to find yield within the fixed income space. This insatiable appetite for yield has driven yields on higher-yielding bond segments like US HY to some of the lowest levels on record – the yield on the Barclays US Corporate High Yield Index recently fell to a new historical low of just 3.53% in early July, before rising to 4.50% as of 18 August 2021.
In contrast, yields on the Asian HY segment have risen precipitously since the start of the year, with the yield on the Barclays USD Asia High Yield index currently at 8.83%, up from the 6.74% at the end of 2020, making it one of the highest yielding fixed income segments anywhere in the bond market today.
2. Valuations are attractive, both historically and also relative to peers
This sharp rise in yields has made the sector much more attractive when compared against its own history, as well as on a relative basis versus other higher-yielding fixed income segments.
On an absolute yield basis, Asian high yield now offers a yield-to-worst of 8.8%, a level seen only in past crises (the depths of Covid-19 pandemic in 2020, and the heightened trade war tensions between China and the US in 2018; see Chart 2).
With lower risk-free rates today, Asian high yield looks even more attractive on a spread basis (see Chart 3), with spread levels on the sector approaching some of the wider levels seen in the depths of the Covid-19 pandemic. Relative to US high yield, Asian high yield also offers a significant level of value, with the current spread difference (512bps) representing one of the widest levels on record, suggesting that Asian high yield is much cheaper relative to its US counterpart.
Chart 2: Asian high yield bonds now offer a yield-to-worst of 8.8% – a level seen only in past crises.
Chart 3: Current spread difference between US and Asia HY (512bps) is at one of the widest on record – suggesting Asia HY is significantly cheaper.
3. More Resilient to Interest Rate Changes Due to Low Duration nature of Asian HY
Another key advantage of Asian HY in portfolios now is its relatively low effective duration versus other HY segments. With its effective duration* at below 3.0 years, Asia HY bonds are least susceptible to a sudden rise in interest rates, possibly brought about by a hawkish shift in Fed’s policy (starting with tapering of asset purchases) (Chart 4).
*Effective Duration: The sensitivity of a bond’s price against interest rate movements. The higher the duration of a credit segment, the larger the bond prices change relative to a unit change in risk-free rates. With an effective duration of 3.0 years, every 1% change in yield will have an approximate 3% change in price for the Asia HY bonds.
Furthermore, high yield bonds, in general, have a greater proportion of its risk premium coming from credit spread. Thus, accumulating more Asia HY bonds in portfolios is a great play for yield pick-up, capital appreciation via spread compression and offers some degree of defense against interest rate risk.
Chart 4: With its effective duration at below 3%, Asia HY bonds are least susceptible to a sudden rise in interest rates among credit peers.
What’s the fund to get exposure to Asian High Yield Bonds?
For exposure to the Asian HY sector, investors can consider adding to our recommended Asian High Yield bond fund, the Eastspring Investments – Asian High Yield Bond ASDM SGD-H.
About the fund
Managed by fund manager Wai Mei Leong – an industry veteran covering Asian credits – this Fund invests in a diversified portfolio consisting primarily of high yield fixed income/debt securities issued by Asian entities or their subsidiaries. This Fund’s portfolio primarily consists of securities denominated in US dollars as well as the various Asian currencies and aims to maximize total returns through investing primarily in fixed income /debt securities rated below BBB-. This is also the SGD-hedged share class of the strategy, which is appropriate for investors looking to manage their investments from an SGD perspective.
What do we like about the fund?
- The fund’s investment philosophy is consistent with our team’s beliefs that opportunities can be captured by identifying cyclical trends and value caused by short-term mispricing of assets –potential for attractive risk-adjusted returns.
- Credit selection and sector allocation form a large part of the fund’s active risk exposure. Strategy’s sector and country positioning is influenced by both top-down macro and bottom-up selection views.
- Managed against the JACI Asia Credit – Non-Investment Grade Index. A highly nimble fund when considering its AUM size versus the number of securities in its portfolio, which may be an advantage during less liquid environments.
- Currently, the fund is overweight on China (53%; as of 30 June 2021) and a 38.5% allocation to the Home Construction sector, due to a constructive outlook on resilient demand and tightening of macroprudential measures. While the fund’s overweight on China’s high yield real estate sector has contributed to its recent underperformance, it’s well-positioned for a recovery play in the Asian HY/China real estate sector, particularly as credit concerns start to wane.
- The fund also sees two key themes potentially playing out in the long-term: one being an increasing emphasis on ESG factors that could affect high yield corporates continued access to funding, and another being companies demonstrating their ability to operate in a sustained lockdown as a result of Covid-19.
How does the fund compare to its peers (in performance)?
Eastspring High yield fund has had one of the better risk-adjusted performances among its peers, over the past 3 years. As of 17 Aug 2021, it has an annualised return of 3.4% (2nd best-performing among the peer group selection) against a similar max drawdown profile of the group. In Table 2, on a 3-year basis, the fund’s Sortino Ratio (0.13) slightly edges out its 3 other peers – except for the Blackrock Asia HY bond fund (0.39)
Table 2: Risk-return attributes of Asian High Yield funds peer group
|Asian High Yield Funds||Blackrock Asian High Yield Fund A2-SGD hedged||Eastspring Asian High Yield ADSM SGD Hedged||Fullerton Asian High Yield Bond Fund||United Asian High Yield Bond Fund||Allianz GI Asian High Yield Bond Fund|
|YTD Total Returns||-2.5%||-3.8%||-2.4%||-5.3%||-4.4%|
|3Y Annual Return||6.6%||3.4%||2.7%||0.8%||0.0%|
|Source: Bloomberg Finance L.P., iFAST compilation. Data as of 17 Aug 2021.|
It has, however, trailed behind the Blackrock Asian High Yield fund in terms of recovery since the March mayhem last year. Prior to the sell-off in March-2020, performance between the two funds was quite close, with the Eastspring fund often providing the best risk-adjusted returns among fund peers. The performance further diverged in recent months, where the Eastspring fund was more severely impacted due to its overweight to the China real estate sector (Chart 5).
Yet, as we argued in the previous section, the fund’s overweight on China’s high yield real estate sector renders it well-positioned for a recovery play in the Asian HY/China real sector, particularly as credit concerns start to wane.
Chart 5: Eastspring Asian High Yield fund has outperformed most of its peers.
What’s the fund manager’s strategy and outlook ahead?
In her latest commentary, fund manager Wai Mei notes that valuations have become more attractive for Chinese high yield property names. In particular, the ‘B’ rated bonds within the sector have corrected significantly. She sees risk premiums relating to the government’s property cooling measures and deleveraging push have been appropriately priced in and have resulted in pockets of value as credits have been indiscriminately sold down.
While the tight financing conditions in the property sector may still exert pressure on weaker issuers, default risk in the sector should remain manageable.
As such, the fund has increased moderately selected China credits within the property sector and financial sector which the Eastspring team believes are valued attractively. At the same time, they are also looking to switch out of China property names which are more susceptible to headwinds due to current scrutiny on liquidity and funding channels.
Overall, the Eastspring team’s views are pretty much in line with our iFAST’s house view and bond analysts’ views on the Asian high yield segment. Hence, we are confident in their strategy and are comfortable with recommending the Eastspring Investments – Asian High Yield Bond ASDM SGD-H fund as the fund for exposure to Asian HY bonds.
Asia High Yields – a recovery play in one of the hardest-hit segments
While no one can predict accurately how the ongoing China real estate sector crackdown will play out, deleveraging will likely hurt the near-term profitability of China real estate developers, as they place a greater emphasis on liquidity.
That said, we don’t expect crackdown measures to permanently impair the business viability of the entire sector, but rather, serve as a wake-up call to real estate companies to focus on debt reduction rather than chasing profitability. Investors can logically expect to see a China real estate sector with a much healthier credit profile emerge post-crackdown, which would be poised for more sustainable long-term growth.
Amid the recent selloff, the Asian HY credits (as a whole) now promise an alluring yield-to-worst of 8.8%. For value-oriented investors, its cheap valuations (high credit spreads) and high-income potential are simply too appealing to pass up on, especially in this low interest rate environment.
That said, investors should be aware that the cheaper valuations (due to the sharp sell-off in Asian high yield bonds) have come on the back of a fair amount of headline risk related to China’s recent crackdown on various sectors and industries. Recent defaults by developers Sichuan Languang and China Fortune Land have made it clearer than ever that the high rewards are stapled with high levels of risk as well.
For investors who remain positive on the long-term China growth story and expect current crackdown measures to abate at some juncture, the China-heavy Asian high yield bond segment ultimately offers a proxy to the recovery of the China real estate sector.