All that junk
Category: Asia, Hong Kong, Japan, Taiwan, Global
By Toby Garrod
Party in full swing; fundamentals slipping out of focus
The Asian high-yield bonds theme is proving to be one of the biggest financial stories of the post-financial crisis era, excluding regulation. Having suffered a low-yield global environment for years, the emergence of this lush oasis has put colour back on the cheeks of institutional fund managers worldwide – particularly those pension and insurance fund managers crippled by negative spread issues. It also stands as a rite of passage to global maturity for many Asian companies, and confirms the continued shift of corporate power toward Asia. But as the weakness from Western economies continues to feed through into Asia, a greater focus on fundamentals is clearly required in this traditionally illiquid market, say market players.
Year-to-mid-September, the JP Morgan Asian Credit Composite index had returned 10.2%, while, the Asian high yield segment outperformed, returning 17.2%. The Chinese property sector was the clear outperformer, returning a hefty 31.8% in the time. Though Asia’s credit market is smaller than those of the US and Europe, it has been growing much faster, with a compound annual growth rate of 30%-plus over the last three years, thanks to solid net issuance.
“US dollar-denominated non-investment grade Asian issuance reached US$15 billion by the end of August, representing 88% of the full-year 2011 issuance level,” says Vincent Ferraton, head of emerging market credit research, fixed income team, at Pictet Asset Management. “We expect full-year issuance levels to exceed their prior year levels. In our view, the heightened level of primary issuance reflects not only historically low funding costs but also the absence of many banks in the syndicated loan markets as well as a strong ongoing investor appetite for higher yielding paper.”
The significant levels of high yield corporate issuance have been strongly driven by investor demand, and issuers seem to be approaching the market opportunistically when credit market conditions are favourable rather than relying on it as one of their primary sources of funding, say investors. China, and to a lesser extent Indonesia, have been dominating the issuance.
“So far this year the issuance of Asian high yield bonds has been limited to repeat issuers which investors are familiar with and the market has shown less appetite for high yield debut names, which usually bear weaker technical support and less investor recognition,” says David Tan, head of investments AllianzGI Singapore and for CIO pan-regional Asian bond mandates. “In terms of Asian high yield bonds, the dominant issuers come from Indonesia (mainly Indonesian coal companies) and China (Chinese property developers and Chinese industrial companies), as well as corporates from Philippines. Chinese property, in particular, contributed to a large portion of issuance, totalling $5.1 billion year-to-date (YTD). Given the improving credit profile of the Chinese property sector and the supportive technical backdrop, we should see more supply from this sector of approximately $1 – $2 billion before year-end.”
Meanwhile, the enormous global demand has brought about a dramatic shift regarding investor landscape that looks set to transform the industry on a permanent basis.
“The number of Asia-based investors has been growing steadily and nowadays accounts for about 60-70% of the Asian high yield corporate space,” says Mr. Tan. “In addition, solid growth dynamics and the expansion of the region’s fixed-income asset class continue to prompt global asset managers to establish a physical presence in Asia and/or funds dedicated to Asia. Retail banks also constitute an important segment of the Asia credit buyer base and, in aggregate, contribute to approximately 15% of the demand for primary deals. For example, the interest from Japan retail investors for high yield remains strong. Japanese retail mandates dedicated to Asian high yield have been a key source of incremental demand for this segment. Demand from Taiwanese retail for Asia high yield is another emerging trend.”
Such positive views of the asset class go to the very top of the investment industry.
“In Europe and Japan, the pension associations actually recommended that their members shift their asset allocations from 60% equity and 40% bonds, to 60% bonds and 40% equity,” says Arthur Lau, Hong Kong-based head of fixed income Asia ex-Japan at PineBridge Investments. “In Japan, in particular, the pension association recommends that investors move into emerging market debt. The Asian bond markets have been significant beneficiaries of these substantial technical and structural inflows.”
Such confidence in the future of the market, and in particular Chinese property firms, is reflected in forecast spreads and yields, though things are perhaps getting tempered.
“The outperformance of Chinese property against Chinese industrials and Indonesian coal is continuing,” says Mr. Tan. “The slightly above-expectation H1 2012 results from Chinese property developers stood in stark contrast against the lacklustre results from Chinese industrials and Indonesian coal. Since July 26, the yield differential versus Chinese industrials narrowed from 50bps to 100bps tighter. The outperformance against Indonesian coal was even more pronounced. Since late July, the pick-up of Chinese larger developers against Indonesian coal issuers was around 210-240 bps. However, on the back of the weak results of Indonesian coal companies, the yield differential of Chinese larger developers over Indo coal then narrowed sharply by a 50-100 bps range. Together with the continuing positive momentum in fund flows, we maintain the view that Chinese property should continue to outperform Chinese industrials and Indonesian coals at least in the near term. We expect further flattening of the credit curve.”
While there are emergent concerns about both the continued growth trajectory of Asia’s high yield bond market and the excess liquidity issues that have plagued the continent for nearly a decade, most investors retain very positive views of the market, at least for the short- to medium-term.
“For the month of September to-date, the Asian high yield corporate space saw various bonds reaching historical highs as flows remained constructive and real money accounts continued to flow in adding high yield risks on pullbacks, even during rallies,” says Mr. Tan. “Looking at the performance of Asian high yield bonds, China property bonds continued to grind tighter over the past month by about 100 bps with an average yield of 9.8%. The sector outperformed China’s industrial names, which, historically, have traded at a premium compared to the similarly BB-rated property bonds. As such, the Chinese industrials credits have only tightened by 70 bps, with average yields of about 11.2% due to their weak H1 2012 results, which priced in rating downgrade risk within this sector.
“The lack of bond supply and the low default risk should support the Chinese industrials bonds’ performance at current levels,” he says. “Given the tight valuations of the Chinese property bonds, the returns will likely be driven more by carry than by capital appreciation for the next few months. However, market technicals remain strong at this point, with robust fund flows over the past few months. We believe this should be a strong supportive factor helping further spread compression. Most, if not all, of the new issues were very well received and significantly oversubscribed, often pricing more tightly than the initial pricing guidance.”
Eyes on the road
Nevertheless, amid the party, it is critical to continually assess the reasons why people are gathering, say market players. To some extent there is market irrationality based on the frustrations of the low-yield environment across the developed world. It is difficult at this point in time to see how many investors are being affected by this, they note. While many have voracious risk appetites, the possibility of the market drying up down the line should be considered, particularly in light of recent economic numbers. Despite the significant loosening of monetary policies across the US, Europe and Japan, Fitch Ratings cut its growth forecasts for China and India by 0.2% and 0.5%, respectively, to 7.8% and 6% on September 28.
“People are not paying much attention to fundamentals,” says Mr. Lau. “On the macro side, the Asian economy is certainly slowing, and we are seeing some disappointing performances in many countries across Asia, including widening trade deficits, falling exports. At the same time, if you look at corporate earnings, Asian companies in general have been reporting worse earning results and expectations than US companies. In terms of fundamentals, we clearly have signs of deterioration at both the macro and corporate levels. Yet it seems that investors are not really discounting such negative fundamentals. They are continuing to favour bonds despite the current tight level.
“While I do think that, to a certain extent, it is quite irrational, I have some sympathy for the managers. If you are a fund manager sitting on a portfolio and have continuing inflows into your account, you can’t accumulate double-digit cash. Those managers are somehow forced to buy into these markets.”