Asian High Yield Bonds - Several hidden gems lurking in this space

• Yields and spreads have gradually normalised over time. With spreads below their 15-year averages, we do not consider the Asian High Yield (HY) market very attractive purely from a valuations perspective.
• Many Chinese property developers are attempting to transition to more sustainable development models, but we believe that the real estate industry may take some time to recover, resulting in a high overall uncertainty for this industry.
• Amidst this backdrop, we think investors can seek bond investment opportunities in four sub-sectors, including (1) Japanese High Yield, (2) Australian High Yield, (3) Hong Kong developers and (4) Chinese Issuers with more international backgrounds.
• Investors can also consider tapping on the expertise of professional fund managers with Asian HY Unit Trusts from Blackrock and Eastspring.

Yield and Credit Spread in Asian High Yield are Normalized Gradually

Since the second half of 2021, following spillover effects from the Chinese real estate crisis, more developers have entered into liquidity crunches and debt defaults. However, the methodologies used in calculating bond indices usually result in these bonds being excluded once their issuers are nearly defaulted or distressed.

These developments have led to a decreasing proportion of Chinese property developers in the Asian HY bond universe (using an ETF as a proxy - see Chart 1), no longer making them the dominant players in the Asian HY market. Instead, Macau and Indian companies have become more significant, while HY issuers from Japan and Australia have also been gradually included in the index, replacing some of the previous exposures to property developers.

Chart 1: Geographical Breakdown and Changes (from 2020 to now)

Since 2022, the average yield and credit spread of the Asian HY universe have remained at a higher level (see Chart 2), owing to higher yields from distressed Chinese real estate bonds. However, said bonds have increasingly been excluded from the index with growing defaults of Chinese issuers. The proportion of Chinese real estate bonds has decreased from around 30% to just about 8% currently.

Chart 2: Asian High Yield – Average Yield and Credit Spread

Yields and credit spreads have gradually normalised over time. Currently, higher yields of 10.4% and credit spreads of 5.8% reflect the potential for higher returns and relative investment value in Asian HY bonds. However, as the credit spread remains below the median (5.9%) and average (6.6%) values of the past 15 years, from a valuation perspective, the market is still not considered very attractive.

Overall Uncertainty Remains High in Chinese Real Estate Industry

While Chinese real estate bonds account for just around 8% of the Asian HY index, the real estate sector still wields a significant influence over the Chinese economy. Therefore, we cannot overlook the outlook of the real estate industry. Along with the “517 policy” introduced in May and other heavy-handed measures in September, we think that policy signs have now reversed. Regarding the property market, we believe policymakers have transitioned their focus from "housing is for living, not for speculation" to the current focus on “halting falls and stabilising”. As a whole, we expect these to lead to a more stable development pattern in the real estate market.

Furthermore, we note that many property developers are attempting to transition from their previous business model, which relied on the "three high" model (high liabilities, high leverage and high turnover), to more sustainable development models. For instance, defaulted developers like Sunac, Shimao, Zhongliang and CIFI are now venturing into the property project management industry. China Vanke has also announced its five-year transformation plan, aiming to increase the proportion of completed property sales and focus on residential development, property management and residential leasing.

This shift may result in property developers (i) increasing the contribution from recurring revenues; (ii) increasing the proportion of completed property sales; (iii) reducing the proportion of sales on uncompleted properties; and (iv) decreasing project turnover speed. These could potentially lower their current high operational risks.

However, with property industry sales and project profit margins dropping to single digits or even turning negative (due to low sell-through rates and high land acquisition costs in the past), combined with ongoing crises in confidence (including consumer confidence from the demand side, and financial institution confidence which affects financing ability), we believe that the real estate industry may not recover quickly. The overall uncertainty remains high within the Chinese real estate sector.

The question is: when should investors adopt a more neutral stance towards the real estate industry? We believe that three key indicators - property sales, housing construction starts and property investment - will be crucial and should be monitored closely. As shown in Chart 3, year-on-year growth rates for these indicators remain negative or at best are showing low positive growth even after these new policies. We would need to see a return to high growth rates (such as 20% year-on-year growth or above) sustained for an extended period (at least one year or more) before concluding the property sector has bottomed out.

Chart 3: Leading Indicators in Chinese Property Sector (Single month YoY%) since June 2021

Bond Investment Opportunities in Four Sub-Sectors

In the Asian HY market, we think investors can seek investment opportunities in four sub-sectors, including: Japanese high-yield, Australian high-yield, Hong Kong developers, and Chinese issuers with more international backgrounds.

1. Japanese High Yield

Japan's transition from a deflationary era to an inflationary environment could stimulate consumption and investment within the country. Meanwhile, the TSE’s ongoing corporate reforms could lead company management teams to focus more on the company fundamentals and restore enterprise value.

A company’s market capitalisation is an indicator of equity financing ability. As shown in Chart 4, an increase in stock prices and consequently equity financing ability can indeed reduce a company's default risk. This could depress a company's credit spread, making it easier for the company to issue debt and borrow at a lower cost, thus creating a virtuous cycle.

Chart 4: The Potential Positive Cycle between Bonds and Stocks of Japanese High-Yield Issuers

Japanese high-yield issuers can benefit from the "Japan Recovery" theme, including Rakuten Group and Nissan Motor (see Table 1). The yield to maturity of their bonds can range from 5.3% to 6.5%, deserving of investors' attention.

Table 1: Selected Japanese High Yield Bonds

2. Australian High Yield

As one of the major resource-exporting countries, Australia's high-yield issuers are primarily metal mining companies and mining service companies, which have benefited from the booming commodities market for metals.

For example, both gold and copper prices are hovering near historical highs (see Chart 5), and iron ore has also experienced a strong rebound due to China's stimulus measures. The higher commodity prices benefit mining companies, with their revenues and profit margins expected to remain at healthy levels, in turn supporting their credit performances.

Chart 5: Trends of Gold and Copper Prices

At the same time, mining service companies are also indirect beneficiaries of a commodities market boom. The growing capital expenditure plans of mining companies (see Chart 6) will drive orders and revenues for mining service companies, especially if commodity prices remain elevated for an extended period. Additionally, mining service companies will have a greater likelihood of raising prices on new contracts, potentially widening their profit margins, while also reducing counterparty risks with their customers.

Chart 6: Capital Expenditure of Mining Industry

Along with the higher for longer outlook on commodities prices, we believe that both mining companies and mining services companies could see improvements in their credit profiles, with the potential for credit rating upgrades.

Table 2: Selected Australian High-Yield Bonds

3. Hong Kong Developers

Hong Kong developers have several advantages, including generally low leverage levels, conservative approaches to land acquisition and new project investments compared to the past, strong financing abilities and a significant number of investment properties available for rental income, long-term appreciation and collateral purposes. As a result, their credit profiles are generally more stable.

Currently, Hong Kong developers continue to achieve high sell-through rates in their new project sales. We think the liquidity of their Hong Kong projects continues to not be a major concern. With normal sales and operations, Hong Kong banks are willing to provide stronger financing support to developers, meaning the actual liquidity pressure on developers is not as significant.

At the same time, Hong Kong developers have adopted a business model with “low liability, low leverage and slow turnover”, which is completely different from the "high liability, high leverage, fast turnover" model adopted by Chinese developers. The latter is more exposed to the risks of the capital chain rupturing. This also explains why most non-SOE developers in China have defaulted on their debts while none of the medium-sized or large Hong Kong developers have defaulted on their debts.

In summary, Chinese developers are facing not only a debt crisis but also a survival crisis, with multiple developers falling like dominoes. On the contrary, the Hong Kong property market is currently only experiencing an industry downturn; Hong Kong developers' operations, sales and financing remain normal. Therefore, we believe that most Hong Kong developers have sufficient abilities to withstand the downturn in the property market, and their credit risks are quite manageable.

Investors could consider some HK bonds listed below (see Table 3), while paying attention to their individual credit profiles before investing.

Table 3: Selected High-Yield Bonds of Hong Kong Developers

4. Chinese Issuers with More International Background

We believe that selecting Chinese issuers with more international backgrounds (see Table 4) provides certain advantages, while also offering higher yields.

Table 4: Comparison of Issuers with More International Backgrounds vs. Purely Chinese High-Yield Issuers

Therefore, we believe that these issuers with a more international background (see Table 5) are more resilient and generally have an advantage over pure Chinese high-yield issuers in terms of debt repayment.

Table 5: Issuers with a more international background

Conclusion

Yields and credit spreads in the Asian HY market have normalised gradually in recent times, and higher yields today reflect the potential for higher returns and relative investment value in Asian HY bonds. However, with Asian HY credit spreads remaining below their 15-year median and mean values, we do not consider valuations very attractive at the moment.

Many Chinese property developers are attempting to transition from their previous business model, which relied on the "three high model", to more sustainable development models. However, with property industry sales, project profit margins dropping to single digits or even being negative and ongoing confidence crises, we believe that the real estate industry may not recover quickly. The overall uncertainty remains high.

Investors can consider searching for bond investment opportunities in the four sub-segments we have highlighted above: (1) Japanese High Yield, (2) Australian High Yield, (3) Hong Kong developers and (4) Chinese Issuers with a more international background.

Those seeking to tap on the expertise of professional active fund managers can consider our primary recommendation Blackrock Asian High Yield Fund, or other funds like the Eastspring Investments - Asian High Yield Bond Fund.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds position in ASLAU 7.500% 26Apr2029 Corp (USD) and RAKUTN 11.250% 15Feb2027 Corp (USD). The analyst who produced this report holds an NIL position in the abovementioned securities.