Cheaper Valuations Make A Comeback For Asian High Yield

• Yields have spiked in Asian High Yield as we are beginning to see the impacts of China’s deleveraging campaign on corporates.
• China’s real estate developers, a major issuer of Asian High Yield debt, is not at immediate risk of near-term credit defaults given their buoyant short-term fundamentals.
• We believe the risk to reward now better compensates investors when investing in Asian High Yield.

As stated in our last update on the top and performing funds, Emerging Markets and Asian High Yield debt turned out to be one of the poorer performers for the first half of 2018 in the fixed income space. Previously we penned our views and investment case for Emerging Markets Debt, and today we will be diving deep into the Asianz High Yield to understand the events shaking up this segment and our thoughts about it.

Credit Risks Driving Spike In Yields

Yields have risen significantly for Asian High Yields fixed income as market sentiment was negatively affected by China being at the crossroads of a trade war and a deleveraging campaign. Relatively speaking, while the Credit Suisse Asian Corporate Bond Index – an aggregate tracker of corporate issues in Asia – has moved northwards by 1.3%, the Credit Suisse Asian BB Bucket Bond Index and Credit Suisse Asian Real Estate Bond Index has risen close to twice in magnitude (by 2.1% and 2.3% respectively) since the start of the year (see Chart 1).

Chart 1: Credit Risks At The Forefront of Asian High Yield Investors’ Minds

The difference in the rise of yields for the various segments of the Asian bond markets tell us one thing: that market participants are pricing in credit risks for non-investment grade (IG) Asian issues more extensively than other fixed income segments at this juncture.

The main detractors leading to the sharp rise in yields for the non-IG space has been coming from the real estate sector from China, seeing that they have been one of the biggest issuers in high yield bonds.

Furthermore, China’s policy action to tighten the financing taps on the onshore bond markets is putting financial strain on certain Chinese firms as we begin to see a wave of onshore defaults.

Alongside the recent property cooling measures set in place by the Chinese government, market participants are growing wary of any strain in real estate developers’ ability to refinance their existing debt pile, considering they often have to borrow at higher yields from offshore markets.

The headwinds described above has dampened investors’ sentiment and has turned valuations much more attractive than before. We believe the current market sentiment has been over bearish as fundamentals within China’s real estate sector remains supporting of an investment case in the presently shunned fixed income segment.

No Bearish Indicators For Real Estate Developers Based On Short-Term Fundamentals

In the past two years, a slew of property cooling measures to stamp out speculative demand has brought stability to housing prices in Tier 1 cities, a main beneficiary of price appreciation in China’s booming real estate market over the last five years (see Chart 2).

Chart 2: Stabilising Housing Prices In Tier 1 Cities

Despite the slowdown in price appreciation, there is still no significant risks on the pricing front for real estate developers, as average selling price of properties is still on a moderate uptrend, across Tier 1, 2 and 3 cities (see Chart 3).

Chart 3: Residential Housing Prices Still Seeing Stable And Moderate Growth

On the demand side, the industry is reporting growth in housing starts and declines in residential housing inventories as demand outpaces the current supply of residential projects (see Chart 4 & 5).

Chart 4: Is Falling Inventory A Sign That Demand Is Picking Up?^

Chart 5: Contracted Sales Still On The Growth Path

Real estate developers’ are also reporting healthy year-on-year contracted sales growth, a gauge of the market’s sentiment (see Chart 6), which should help to support the developers’ current and near-term credit profiles.

Chart 6: Y-o-Y Median Growth Of Top 10 Largest Real Estate Developers’ Contracted Sales

Although a clampdown on speculative real estate investments has successfully reduced prices from soaring quickly, the data suggests there is underlying organic demand for housing in China, which leads us to believe that the ongoing secular trend will continue to drive real estate developers’ profitability, and ability to grow and service their existing debt in the near term.

Deleveraging Is Important, But So Is The Real Estate Industry

Although deleveraging is a policy goal, the Chinese government also has a vested interest to keep the real estate industry alive and well, considering that real estate and its peripheral industries contribute to 15-20% of the country’s GDP.

Any impact to the industry’s growth will undeniably make a dent in the country’s growth targets and rock the boat that is already trying to adjust to the ongoing deleveraging drive. Yet, unlike Western democracies, the government’s grip over monetary policies gives it the ability to execute required policies at will in steering the economy.

But has the ability to defuse risk translated to the willingness of the government to do so? Presently we have seen developments on the regulatory front in keeping a lid on prices. To that end, real estate practices of hoarding unsold homes and market manipulation, among others, are being cracked down in a bid to stamp out asset speculation.

Policymakers have also tailored policies specifically to real estate developers, such as making debt repayment a priority for developers issuing offshore bonds, before they can use the remaining funds for replenishing working capital and land investments.

All of this is even before considering the fact that China has barely flexed its monetary muscle should their regulatory efforts turn futile, which appears unlikely at the moment, given that housing prices have found some much needed respite.

The current set of information suggests that China, rightfully within their long-term interests, can and will continue to ensure the real estate sector remains stable for the foreseeable future.

Sufficient Risk To Reward Is Finally Materialising

As of 25 July 2018, we are looking at yields of 7.7% for the Bloomberg Barclays Asian High Yield Index, a relevant aggregate gauge that covers both the Asian High Yield and Asian Real Estate fixed income segments.

The current yields are reminiscent of tumultuous periods of the recent past, such as the taper tantrum episode in 2012-13 when markets harshly reacted to the Fed scaling back its bonds buying program, and during 2015-16 when market participants were anticipating a hard landing for China’s economy, which of course did not materialise.

Against some of its Asian IG, EM High Yield and Global fixed income peers, Asian High Yield bonds now offer investors one of the highest yield and lowest duration available in the fixed income market today (see Chart 7).

Chart 7: Asian High Yield Against Other Fixed Income Peers

Following a rally of both equity and fixed income assets in 2017, Asian High Yield generally did not offer compelling value from a risk to reward perspective. Now that valuations have eased, we believe current levels of yield better compensates investors for the risks they undertake.

Which Funds Should I Pick To Gain Exposure To Asian High Yield?

As mentioned, Asian High Yield funds are largely exposed to non-IG corporate bonds and have a greater concentration within the real estate and financial sectors.

Given the poorer financial positions of these issuers, credit risk is one factor we are more watchful of in our fund selection process, and we prefer funds with greater exposure to larger issuers over smaller ones. Besides, we also like funds that invest in offshore bond issues as the credit profiles of these corporate issuers are often more robust than onshore counterparts.

Therefore we believe selecting managers who are more active in offshore credit selection becomes increasingly important when investing in this space.

With the above consideration, we have singled out two funds that investors may consider in gaining exposure to this fixed income segment, one being the Fidelity Asian HY AMDIST SGD Hedged, our recommended fund for 2018 for our Core Bonds – Asian High Yield category, and the other being the Allianz Dynamic Asian HY Bd Cl AMg Dis H2-SGD.

Enter The Window Of Opportunity Before It Closes!

Those with skin in the game might wish to hold on to their investments and not crystallise their losses, since we think the risk to reward trade-off for Asian High Yield debt is looking attractive again. Likewise with how you do not buy at peak valuations, similarly you do not sell when prices are near the bottom.

Now is perhaps the best time for vultures whom have been awaiting on the side lines to pounce on excellently valued investments to consider this fixed income segment. Instead of a lump sum investment, we recommend interested investors to spread out your entry points to mitigate any further weakness in valuations that may come with the news cycle surrounding the deleveraging efforts in China.

The Research Team is part of iFAST Financial Pte Ltd.