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Asian High-Yield: Another bond segment on sale?
THE Asian High-Yield space has seen a tumultuous 12 months, with yields climbing rapidly from its lows of 4.51 per cent in April 2017 to 7.55 per cent as at Aug 17, causing losses among investors who are holding this asset.
Most Asian High-Yield funds operating with a SGD-hedge had incurred losses of about 6 per cent on a year-to-date basis as at Aug 16.
With China and Hong Kong accounting for over 60 per cent of the market, a large proportion of the fate of Asian high yield is linked to the Greater China region, in particular the Chinese real estate sector, which accounts for about 32 per cent of the benchmark. Thus, a focus on China is appropriate.
The recent period of rising yields was driven mainly by the widening of credit spreads, attributable to a few offshore defaults, the effects of the deleveraging campaign in China, and the escalation of trade tensions between the US and China, where growth has decelerated.
In addition, there were market whispers that policymakers had stopped Chinese corporates from issuing new USD denominated debt, a rumour that sparked a sell-off and a surge in yields. These rumours were later clarified by the authorities.
While China is poised to continue on its deleveraging path, we have seen policymakers fine-tune policy to support the economy, given the recent moderation in growth and the rise in trade tensions. The Chinese government has announced both fiscal and monetary policy measures to stabilise domestic financial conditions, boost domestic demand and thus strengthen economic growth. Some of the measures include cuts in the reserve requirement ratio for banks to free up funds for lending, which has encouraged banks to increase lending (especially to small and medium-sized enterprises), corporate tax cuts, and more recently, an acceleration in infrastructure spending plans.
This has helped to underpin financial and liquidity conditions on the mainland and steady investor sentiment and Chinese High-Yield credits, particularly those belonging to Chinese real estate developers.
Asian High-Yield bonds' higher yield and short duration help it to mitigate a rising interest rate environment. However, the main risk is credit risk (or the risk of default), rather than interest rate risk. While there has been an increase in the forecast default rate for 2018 for Asian high yields from about 2.2 per cent at the beginning of the year to 2.8 per cent (based on JP Morgan & Co forecasts), the current expected default rate is not expected to be debilitating for the segment.
Corporate fundamentals have remained broadly intact, with earnings displaying healthy growth. The top 10 largest Chinese property developers have continued to report strong double-digit sales growth of close to 35 per cent. House prices on the mainland continue to see moderate increases as inventory declines and demand outpaces supply.
For Asia as a whole, large-cap corporates are expected to post earnings growth of approximately 8 per cent in 2018 and 11 per cent in 2019, while small caps' earnings growth is estimated at 24 and 18 per cent for 2018 and 2019, respectively. With the expectation of strong profit growth, fundamentals continue to look healthy which should enable Asian corporates to fulfil their debt servicing obligations.
As current valuations for the segment offer a fair risk premium (spreads are close to their historical averages), and yields are close to six-year highs, investors who have been hunting for yield and can stomach the credit risks should at least give Asian high-yield bonds a second look.
Given the credit risks inherent in the high-yield space, investors should take a diversified approach to prevent any potential default from wrecking one's portfolio. In the funds space, investors have several options, such as the Allianz Dynamic Asian High-Yield Bond Fund, Eastspring Investments-Asian High-Yield Bond Fund and the Fidelity Funds-Asian High Yield Fund to consider; all three come with varying positioning as well as conviction in terms of number of holdings and degree of diversification.
The fund with the highest portfolio concentration and conviction would be the Allianz Dynamic Asian High-Yield Bond fund, which has 115 holdings and 66 per cent of its portfolio allocated across China and Hong Kong as at end June. Diversifying away from high-yield credits, the fund holds 1.2 per cent in investment grade names and have 5.5 per cent is allocated to sovereign debt (there are only three high-yield sovereigns in the benchmark). The fund posted a yield-to-worst of 8.8 per cent as at end-July 2018.
Eastspring Investment-Asian High Yield Bond Fund was incepted in 2012. As at end-June, the fund held 205 securities, and 58 per cent of the portfolio was in Chinese and Hong Kong credits. The fund has invested approximately 3.2 per cent in investment-grade debt and 7.6 per cent in sovereign and quasi-sovereign exposure, which lends it a bit more diversification away from Asian high-yield credits. The fund posted a yield-to-worst of 7.9 per cent as at end-July 2018.
The Fidelity Funds-Asian High-Yield Fund is most diversified among the three funds in terms of number of holdings; the portfolio held 229 securities at end-June. The portfolio is 43 per cent allocated to China and 10 per cent to Hong Kong. About 6.7 per cent is in investment-grade securities; 4.8 per cent in sovereigns and quasi-sovereigns; and 4 per cent in cash. The fund posted a yield-to-worst of 8.7 per cent at end-July.
With a reasonable spread and attractive yields of over 7 per cent on offer in the Asia high-yield segment, active management and diversification are needed to help select the right credits and ensure that credit risk is well mitigated while coupons are clipped.
- The writer is the assistant director of the research and content team at fundsupermart.com (FSM). FSM is the business-to-consumer division of iFAST Financial, the Singapore subsidiary of iFAST Corporation