Asia high-yield bonds still attractively valued
They offer falling default rates, high yields and diverse opportunities across a range of countries and sectors
AFTER several challenging years brought on by China’s property crisis, Asia high-yield (HY) bonds delivered a showing in the first half of 2024 stronger than in any comparable period since the global financial crisis.
As represented by JACI Non-Investment Grade Index, Asia HY recorded a total return of 10.5 per cent as at end-June 2024, outperforming other major credit markets; these included US HY (+2.6 per cent, Bloomberg US Corporate High-Yield Bond Index) and global HY (+3.2 per cent, Bloomberg Global High-Yield Bond Index), which have been more sensitive to rate volatility.
While the distressed segment led the rally, high-quality Asia HY bonds also performed well. The HY index, excluding CCC-rated securities, delivered 8.5 per cent in total return. This robust performance is unsurprising, given the asset class’ elevated starting yield of 14.5 per cent (or 11.8 per cent, excluding CCC-rated bonds), and the stable or even improving credit fundamentals outside China’s property sector – as we have been highlighting over the past two years.
As the Asia HY market approaches the end of its latest default cycle, we believe it continues to offer attractive valuations and opportunities for disciplined credit selectors, due to the following factors:
1. Declining overall default rates and healthy Asia ex-China property sector
The Chinese property sector crisis caused Asia HY corporate defaults to spike to 16.8 per cent in 2022, and 1 per cent in 2023. With the sector now much smaller, we expect default rates to continue to moderate to an estimated 4.5 per cent this year.
Moreover, the rest of the market has remained healthy. Excluding China property, default rates in the asset class stood at a mere 0.3 per cent in the first half of this year. We expect 2024 and 2025 default rates to stay below the historical average of 2 per cent for Asia HY ex-China property.
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While defaults in Asia have dominated headlines in recent years, Asia HY ex-China property has historically maintained a lower default rate than US HY. We expect this trend to continue over the next two years, supported by the region’s healthy macroeconomic backdrop, issuers’ robust access to cheaper local funding channels, and a fairly distributed maturity schedule.
2. Improved diversification in regional and sector composition
Compared to three years ago, the Asia HY market is now much more diversified. China’s weight in the JACI HY index has fallen significantly, from over 50 per cent in the second quarter of 2021 to 25 per cent in the second quarter of this year.
Notably, China HY real estate – once the largest segment of Asia HY with a 35 per cent weight – is now less than 10 per cent of the market and is expected to shrink further over time. The rebalancing of the index results in increased diversification for investors, allowing them to mitigate challenges in specific sectors or regions with opportunities in other market segments and reducing risk overall.
3. High-yield carry
Asia HY continues to offer higher yields relative both to historical averages and developed market HY bonds. Asia HY’s 12.3 per cent yield was some 4.4 percentage points higher than the yield for US HY as at end-June 2024.
Even excluding the lower-quality buckets, JACI HY ex-CCC is yielding 10.5 per cent and JACI HY ex-China is yielding 9.9 per cent – still higher than developed market HY.
These levels are at the higher end of their 10-year historical range, close to the 90th percentile. In addition, while credit spreads for many markets have narrowed to some of their tightest levels since the global financial crisis, Asia HY is one of the few market segments that still offer potential for spread compression.
China outlook
On China, the government has unveiled its most significant steps yet to tackle the three-year slowdown. The policy measures have been highly targeted to manage growth and avoid systemic risks, as we expected.
We view the recent supportive measures for the housing market as positive steps towards reducing the risk of a further deflationary spiral, but we believe more action is needed to stabilise the property market. We remain cautious on the outlook for the sector and believe investors should stay highly discerning, focusing on select names with quality rental portfolios.
Still, the dramatic reduction in the size of China’s property bond market means that the Asia HY universe is now more diversified than it was three years ago, and the sector’s impact on overall index returns is much less significant than before.
Outside of property, we see opportunities in select industrial companies in China. These are benefiting from pro-growth policies and the loose monetary policy stance, which is bolstering access to cheap funding. The onshore and offshore funding cost differential remains significant, creating dislocation opportunities in the offshore bonds of select high-quality HY companies that have access to onshore channels.
Opportunities beyond mainland China
Away from the mainland, the macro environment of the broader Asian market remains robust, and we continue to see opportunities for investors to gain exposure to the world’s fastest-growing region.
We continue to favour Macau’s gaming sector, where fundamentals are still improving following the territory’s Covid reopening. Macau’s gross gaming revenue has recovered to 75 per cent of its pre-Covid levels, and we expect gaming Ebitda to surpass pre-Covid levels in 2025. We believe bonds will enjoy support from the positive credit-rating trajectory and issuers’ proactive management of maturity profiles.
We see opportunities in select Indian corporates that are well-positioned to benefit from the country’s robust economic expansion. One example is the renewable energy sector, which continues to benefit from structural tailwinds catalysed by the country’s ambitious goal of generating half its electricity from non-fossil fuels by 2030.
We also like select commodity-related issuers in Indonesia. These companies have strengthened their balance sheets and are also benefiting from cheaper local funding channels, which enhance their financial flexibility.
In conclusion, Asia HY bonds present a compelling investment case, offering falling default rates, high yields and diverse opportunities across a range of countries and sectors. In this dynamic environment, active managers with robust investment processes are well-positioned to generate alpha.
The writers are co-heads of Asia fixed income, PineBridge Investments
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