A monthly review and outlook of the Asian Quality Bond market.
Market review - as at August 2020
The overall backdrop for Asian credit was little changed, with positive momentum from July continuing well into August. The outlook for corporate earnings remained mixed, at best, and news releases suggested companies in various sectors across the region continue to face serious financial pressures. In spite of that and the historically low yields on offer, demand from income-oriented investors remained insatiable.
Primary issuance remained very active and there was strong demand for new tenders. Most order books were covered multiple times, enabling companies to issue the new debt at premium valuations. New issues were typically completed 45-50 bps tighter than initial price guidance, underlining the ongoing strong appetite for credit in the region.
The Federal Reserve continued to buy investment grade corporate bonds in the US and investors appeared confident that this very large buyer would increase its purchases to help support valuations on any sign of weakness. This thematic has exerted downward pressure on credit spreads globally and has provided a tailwind for corporate bond valuations in all major regions over the past few months.
US Treasury yields edged higher during the month, perhaps reflecting an increase in supply as authorities look to finance massive virus-related fiscal support packages. This offset the narrowing in credit spreads and acted as a drag. As a result, the JACI Investment Grade Index declined -0.10% over the month.
The First Sentier Asian Quality Bond Fund returned 0.31% for the month of August on a net-of-fees SGD term.
The positive return was largely attributed to strong performance in Singapore banks including DBS and UOB. Our short duration positioning in US interest rate also protected the portfolio from losses resulting from rising US treasury yields.
On a year-to-date basis, the strong positive return for the fund was largely due to the spectacular rally in US treasury. The continued recovery of credit spreads from the March lows also contributed to recent performance even though they are still wider than the levels at the start of the year.
On a relative basis, the fund has fully recovered from the underperformance during the March sell-off. Our exposures in CNY and SGD has also been adding value as these two currencies continued to strengthen against the US dollar. The yield on the Chinese quasi bonds we hold also present us with significant pickup over US treasuries.
Annualised performance in SGD (%) 1
Cumulative performance in SGD (%) 1
Asset allocation (%) 1
Top 10 holdings (%) 1
* The benchmark displayed is the JP Morgan Asia Credit Investment Grade Index (SGD Index) (Hedged to SGD).
1 Source: Lipper, First Sentier Investors. Single pricing basis with net income reinvested. Data as at 31 August 2020. The First Sentier Asian Quality Bond Fund inception date: 1 November 2016.
The Fund participated in new issues from Malaysian telecom company Axiata Group, car maker Great Wall and conglomerate Yunda Holding, both from China. These purchases added further diversification to the portfolio.
On the sell side, we took profits on Indonesian quasi bonds Pertamina and PLN and India’s Power Finance, all of which had been purchased during the market sell-off in March and April.
The Fund’s credit spread duration was reduced to almost neutral during the month. This reflected a more cautious outlook following the strong rally since April. The momentum in credit markets remains strong, but we are cognizant that the COVID-19 pandemic continues to have a significant adverse impact on Asian economies.
Q3 2020 investment outlook
What started as a health crisis has now morphed into an economic crisis as COVID-19 continues to impair business activities, increase unemployment and erode consumer’s confidence. The pandemic is also likely to have a far-reaching impact on society, even after restrictions are lifted. Hence it is plausible that financial markets could continue to react to the number of new cases and fatalities, the progress made on developing a vaccine, and concerns around a second wave of infections.
Prospects for an economic recovery in the months ahead remain unclear, particularly as there have been signs that economies that are reopening are facing heightened risks of another round of widespread infections. Lockdowns seem likely to be reintroduced in some areas, bringing unintended consequences including poverty, mental distress and a dysfunctional society. Central banks and governments have rolled out large monetary and fiscal stimulus packages to help soften the blow of virus-related closures and disruptions. The level of support has been unprecedented; authorities seem willing to do whatever it takes to prevent a complete collapse in economies.
Equity and credit markets have been quick to acknowledge the scale of these support packages. Some stock markets, for example, have recovered in a ‘V’ shape, rebounding close to pre-virus levels. It appears investors are willing to look through expectations of weaker corporate earnings towards a ‘normalization’ in economic conditions and profitability as virus-related restrictions are lifted. We acknowledge that economies will recover in due course and that the pandemic will eventually pass, but we are becoming increasingly uncomfortable with overall level of debt globally. It seems likely that some countries will be unable to service their debt repayment obligations in the future. If and when this occurs, it could trigger a new financial crisis that dwarfs anything we have seen before.
November’s US Presidential election is another development that will increasingly affect sentiment in the months ahead. There could be some volatility in risk assets as candidates’ campaigns gather steam and as their policies are announced. Speeches made by the two forerunners – Republican Donald Trump and Democrat Joe Biden – will be closely scrutinised. Markets could enter a ‘risk off’ phase if Biden maintains his current lead in national polls and looks likely to take control of the Senate and the White House. He has proposed more than U$3 trillion of new taxes and tighter regulations, which could act as a headwind for large parts of the economy. On the other hand, if Trump looks like being re-elected, risk assets could conceivably rally further as investors embrace his progressive economic policies. All of that said, market price action brought about by the US election could prove temporary. Back in 2016, markets perceived a Trump victory to be “unthinkable” prior to the election, but both equities and credit rallied strongly and US Treasury yields rose after Trump won; the opposite of what markets had anticipated. Ultimately, investors must focus on what can be realistically be achieved by the US economy without focusing too much on the promises of the two Presidential candidates.
All in all, the third quarter of 2020 starts with even more uncertainty than we saw back in April. Accordingly, given the strong recovery in Asian Investment Grade credit in the second quarter, we have become more cautious and are looking to preserve the gains that have already been made. Avoiding defaults and deteriorating issuers is likely to become even more important for investors in the months ahead, underlining the importance of careful issuer selection and ongoing monitoring. We are not anticipating a repeat of March’s meltdown in credit markets, but that episode nonetheless reinforced the importance of maintaining exposure to high quality, liquid investments during periods of stress.
Source : Company data, First Sentier Investors, as of 31 August 2020
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