Global credit markets have been challenged in 2018 and spreads have widened. Asian issuers have not been immune from this volatility. Following another default by a Chinese issuer, we take stock of where markets are currently, what opportunities (if any) are present in the region, and outline how investors can gain exposure to the asset class if desired.
Asian credit markets – taking stock
Historically, Asian Investment Grade and High Yield credit spreads have traded at a premium relative to US issuers. Towards the end of 2015, however, demand for Asian High Yield exploded, resulting in spread narrowing. In fact, for most of the following two years, Asian High Yield spreads were narrower than High Yield spreads in the US. Brief periods where Asian High Yield spreads widened during this period saw buyers emerge in force, capping any widening. As shown in Figure 1, this demand meant Asian High Yield spreads traded in line with US High Yield spreads at the end of 2017.
Figure 1: Asia HY spreads over US HY
Source: BBG and Barclays Index
Whilst for long periods the fundamentals for Asian High Yield were – and may remain – sound, we believe investors were placing too much emphasis on yield. When considering investment drivers, it is important to consider multiple drivers such as fundamentals and liquidity, as well as yield.
For some time, we have felt that it may be more prudent to pay greater attention to liquidity rather than yield (or even fundamentals) when investing in Asian High Yield credit. A simple, common sense approach has served us well in assessing liquidity. By January 2018, High Yield spreads had narrowed to their tightest levels since 2008 in both Asia and the US and there was little difference in spreads between the two markets. In considering liquidity as a driver, however, we note that the size of the Asian High Yield market is around USD200 billion. By comparison, at around USD2 trillion, the US High Yield market is roughly ten times larger. In short, investors were paying insufficient attention to liquidity. Perhaps investors should have been paying more attention to the relative illiquidity of the Asian market. In 2018, Asian High Yield spreads have widened sharply, from a low of 277bps in mid-January to 469bps at the end of May.
It is important to note that using the index spread as a gauge is a blunt measure of performance. We have observed an increased dispersion in the performance of High Yield bonds in the Barclays Bloomberg Asian USD High Yield Index, underpinning the need for quality credit research, active management and the use of non-traditional gauges of risk, such as ESG. Some individual names have performed significantly worse than the broader universe. While we continue to hold some Asian High Yield names in our mixed grade strategies, a focus on quality and liquidity in our credit research process has, on the whole, helped us avoid the underperformers.
In comparison, the Asian Investment Grade sub-sector has remained reasonably resilient and we continue to promote this lower volatility option to investors. Asian Investment Grade spreads narrowed to post-2008 tights in January 2017, but have tracked US Investment Grade spreads wider since, highlighted in Figure 2 below.
Figure 2: Asia IG spreads over US IG
Source: BBG and Barclays Index.
The drivers of volatility – global versus regional
The re-pricing of credit markets globally is not coincidental. Having ended January 2018 in great shape, a barrage of events have weighed on credit markets in spite of the global synchronized growth outlook and favourable credit fundamentals. When markets become expensive (for example in January when credit spreads were tight and when equity markets were hitting highs), they typically look for reasons to correct. Indeed since January there has been no shortage of issues for investors to agonize over. From Trump to North Korea, the prospect of trade wars, rising US rates, the end of QE in Europe, the rise in Libor-OIS, emerging market jitters in Argentina and Turkey and, most recently, political uncertainty in Italy. What next? Given the amount of uncertainty and geopolitical risk in the world, it certainly appears unlikely that markets will calm in the immediate future. Investor behaviour has changed in recent months in response to these issues. Abundant liquidity in recent years saw investment into fixed income that was almost price-insensitive. But the world is changing. Liquidity taps that have been held open by central banks for so long are being reduced to a trickle, or even being turned off completely. Investor behaviour is changing in recognition of this.
In 2018, Asian fixed income investors have become far more discerning in their behaviour, compared with the indiscriminate purchasing in recent years. As well as dealing with uncertainty associated with the above events, Asian fixed income markets have seen defaults in China – albeit modest in quantum – on their doorstep. We anticipate further defaults, although see this as a healthy evolution of an efficient market and preferable to Chinese authorities supporting poor quality institutions. There were 20 bond defaults in China in the first five months of 2018, but the onshore default rate remains lower than Chinese banks’ nonperforming loans and is significantly lower than the global average default rate. If we assume the recent pace of Chinese defaults will continue and use Chinese onshore defaults as a proxy for Asia High Yield more broadly, the outcome and outlook for the local market appears more favourable than the global high yield average.
Figure 3: Global Corporate Defaults
*Default rate. **Asia, excluding Japan
Opportunities and options
Depending on your outlook for global market volatility, it may or may not be time to look more closely at those names that have driven the dispersion in the Asian High Yield Index. Whatever view held, the shift in markets appears likely to be permanent. A disciplined, discerning, research-backed approach will be key in selecting the best companies from the not so good, underlining the importance of active management in this sector.
Investors seeking access to Asian credit essentially have two options available. If they believe the volatility backdrop will continue, a focus on Asian Investment Grade Credit may suit. If they believe the re-pricing of assets has added value to markets but that volatility will continue, a mixed grade Asian strategy managed by a highly experienced team of professional investors may be preferable.
For a list of all the available share classes for the First State Asian Quality Bond Fund and First State Asian Bond Fund (including currency hedged options), please visit www.firststateinvestments.com.
These figures refer to the past. Past performance is not a reliable indicator of future results. For investors based in countries with currencies other than the share class currency, the return may increase or decrease as a result of currency fluctuations.
Performance data is calculated on a net basis by deducting fees (a model fee of 40bps has been applied) from a gross of fee return. The internally calculated gross of fee return excludes all costs (e.g. custody costs), save that it does not exclude costs associated with buying or selling securities within the portfolio. Income is re-invested on a gross of tax basis. Source: Lipper IM / First State Investments (UK) Limited.
For further institutional enquiries contact firstname.lastname@example.org
For wholesale enquiries contact email@example.com
This document has been prepared for informational purposes only and is only intended to provide a summary of the subject matter covered and does not purport to be comprehensive. The views expressed are the views of the writer at the time of issue and may change over time. It does not constitute investment advice and/or a recommendation and should not be used as the basis of any investment decision. This document is not an offer document and does not constitute an offer or invitation or investment recommendation to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this document.
This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy, or completeness of the information. We do not accept any liability whatsoever for any loss arising directly or indirectly from any use of this information.
References to “we” or “us” are references to First State Investments.
In the UK, issued by First State Investments (UK) Limited which is authorised and regulated by the Financial Conduct Authority (registration number 143359). Registered office Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB number 2294743. Outside the UK within the EEA, this document is issued by First State Investments International Limited which is authorised and regulated in the UK by the Financial Conduct Authority (registered number 122512). Registered office: 23 St. Andrew Square, Edinburgh, EH2 1BB number SCO79063.
Certain funds referred to in this document are identified as sub-funds of First State Global Umbrella Fund, an umbrella investment company registered in Ireland (“VCC”). Further information is contained in the Prospectus and Key Investor Information Documents of the VCC which are available free of charge by writing to: Client Services, First State Investments (UK) Limited, Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB or by telephoning 0800 587 4141 between 9am and 5pm Monday to Friday or by visiting www.firststateinvestments.com. Telephone calls may be recorded. The distribution or purchase of shares in the funds, or entering into an investment agreement with First State Investments may be restricted in certain jurisdictions.
Representative and Paying Agent in Switzerland: The representative and paying agent in Switzerland is BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich, Switzerland. Place where the relevant documentation may be obtained: The prospectus, key investor information documents (KIIDs), the instrument of incorporation as well as the annual and semi-annual reports may be obtained free of charge from the representative in Switzerland.
First State Investments (UK) Limited and First State Investments International Limited are part of Colonial First State Asset Management (“CFSGAM”) which is the consolidated asset management division of the Commonwealth Bank of Australia ABN 48 123 123 124. CFSGAM includes a number of entities in different jurisdictions, operating in Australia as CFSGAM and as First State Investments elsewhere. The Commonwealth Bank of Australia (“Bank”) and its subsidiaries do not guarantee the performance of any investment or entity referred to in this document or the repayment of capital. Any investments referred to are not deposits or other liabilities of the Bank or its subsidiaries, and are subject to investment risk including loss of income and capital invested.