LAST July, a fellow columnist wrote about opportunities within the Asian high yield (HY) bond segment when investors raced for the exits as yields climbed. One year forward, I think it is apt to revisit this bond segment and review its attractiveness.
The performance of Asian HY year-to-date is nothing short of excellent. Having ebbed and endured through various market sell-offs in Asia and across the world, Asian HY has rebounded strongly in 2019.
Based on the performance of various Asian HY funds available to retail investors in Singapore, those who held onto these riskier credits would have been rewarded with a year-to-date total return of anywhere from 6 to 9 per cent as at June 25 in SGD terms. This range fluctuates depending on whether there was a currency hedge used. The strong performance comes on the back of several policy responses.
Firstly, China had to backstop on its deleveraging drive and shift gears as the US-Sino trade war could not have come at a worse time. Besides increasing tax cuts for businesses and consumers and committing further infrastructure investments, the Chinese government has opened up new funding channels for private firms. Less creditworthy corporates previously reeling from refinancing difficulties are now relieved from credit pressure.
Secondly, the position of economic strength the US had in the US-Sino trade dispute is waning as its economy is now decelerating at a faster rate than the rest of the world. The expectation of several rate cuts by markets and dovish statements by the Federal Reserve over the latest FOMC meetings are indicative of a likely slowdown, which also suggest we are at the end of the current rate hike cycle.
Cheap credit
Risky assets, especially the high yield credits, are cheering the fact that credit is once again cheap and easy to access. Expectations for rate cuts also imply a weakening dollar, which would benefit Asian corporates which primarily rely on dollar-denominated financing, despite deriving much of their revenue in local currency.
While markets are starting to turn optimistic once again, I believe Asian HY investors who benefited from the risk-on move should consider adopting a neutral stance on this bond segment. The market is a pendulum eternally swinging between optimism and pessimism which makes risk assets too expensive or too cheap. In the wake of recent market optimism, I believe now is a good time for investors to trim and take some profits off their positions.
From a valuations perspective, the attractiveness of Asian HY relative has diminished. Credit spreads, which indicate the yield compensation to the investor for holding a riskier bond compared to a risk-free bond (for example, US 10-year Treasury), have narrowed by 94 and 205 basis points as at June 24, 2019 for BB-rated and B-rated issues respectively, which are slightly below their respective nine-year averages of what some consider to be "fair value". By no means am I bearish on Asian HY but I no longer see an asymmetry in risk-to-reward for this bond segment.
Theoretically, we could continue to see spreads narrowing to levels as observed throughout 2017 or lower, but betting on that outcome is a hard pill to swallow. Unlike in 2017, the narrative we are in has shifted 180 degrees from a scenario of global synchronised growth to one of a global synchronised slowdown and greater political uncertainty.
From a longer term perspective, there are risks the market could be under-appreciating at this point. Once the trade war overhang fades, China will likely want to resume its deleveraging campaign as it still faces overcapacity in certain parts of its economy, especially in local government financing vehicles (LGFVs) owned by provincial governments. There is also risk of further escalation in trade disputes. Coupled with a slower growth outlook ahead, it is difficult to remain overly optimistic on Asian HY now that valuations have normalised.
Regardless, it is important to continue to have some exposure to the Asian HY segment as part of a globally diversified portfolio; current yields should continue to appeal to investors seeking income-accrual strategies. Asian HY remains as one of the brightest spots in terms of yield carry, offering yield-to-worst of mid-7 per cent. In comparison, US HY is only offering a yield-to-worst of about 6.0 per cent.
Investors who prefer clipping higher coupons and are willing to withstand greater volatility may consider the Allianz Asian High Yield Bond Fund. The strategy is managed with high conviction given its geographical overweight positioning, with about 70 per cent of its holdings in China and Hong Kong. The fund sports a higher yield-to-worst of 9.46 per cent with a duration profile of 1.95 years as at end-May 2019.
Those willing to take the middle road in terms of yield and risk may consider the Eastspring Investments - Asian High Yield Bond Fund. The fund is diversified across 231 bonds with a yield-to-worst of 7.8 per cent and duration of 2.90 years as at end-May 2019. Relative to other funds, Eastspring Investments - Asian High Yield Bond Fund has the largest exposure to Indonesian and Indian bonds which will probably favour investors with a positive view on the economies' credit outlook. Do take note that June's yield figures for the above two funds are likely to be slightly lower.
Another consideration investors may have is the United Asian High Yield Bond Fund. The fund's conviction comes from its bond selection as seen from its high relative portfolio concentration of 66 bond issues. Despite the higher security concentration, the fund positions itself fairly defensively, sporting a yield-to-worst of 7.85 per cent and duration of 2.20 years as at end June 2019. The fund also has the largest proportion of Singapore bonds among the three at 11 per cent.
Some may consider my decision to take some profits off the table a tad too early but hitting home runs of selling at peaks is easier said than done. The secret to building up one's investment portfolio over the long term, I believe, is to have the courage to hop off the elevator on the way up to reduce and manage potential downside risks which are inevitable across market cycles.
- The writer is the unit trust analyst of the research & portfolio management team at FSMOne.com. FSMOne.com is the Business-to-Consumer (B2C) division of iFAST Financial Pte Ltd, the Singapore subsidiary of SGX Mainboard-listed iFAST Corporation Ltd.
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