Harnessing alpha opportunities
The Asian credit market has entered a new, resilient phase, creating interesting opportunities for investors.
Deputy Chief Investment Officer and Head of Fixed Income at the firm, Angus Hui, believes the market has evolved since the Asian financial crisis and global financial crisis to become more stable and defensive.
“The latest phase is a regime change. The lessons that have been learned from the previous two crises have made Asia more resilient. With challenges in the banking sector in the US and Europe, Asia is a more stable market that offers interesting propositions for investors both in the region and potentially outside the region as well,” Hui says.
He explains that the yield curve on US Treasury bonds has been inverted for some time, with the gap between the two-year and ten-year US Treasury Rate currently around 40 to 50 basis points.
“A lot of Asian credit by nature, particularly investment grade, is quite short dated. This gives investors an opportunity to potentially receive a yield of 5% to over 6% for a few years.”
He adds that some top quality, corporate single A credit is now available with a yield that is higher than that offered by double B credit from China, India and Indonesia in the past. “The risk-reward in the market is better. The Federal Funds rate has gone up from close to zero to 5%.”
Despite the opportunities it offers, the Asian credit market is not without challenges. One of these relates to structural changes to the market, which now has a lower level of high-yield primary issuances.
Hui explains that the reduction is partly due to high quality names being able to meet their funding requirements through the banking system and the domestic market, reducing the need to use the dollar market. Companies, particularly those in China, are also going through a deleveraging phase. Most Chinese property companies are unlikely to return to the USD capital markets in coming few years.
“In some ways this makes our market healthier, but we do have a lower level of high yield bond issues. At present, the single B-rating bloc accounts for just over 2% of the overall Asian credit market now, where just over three years ago it was 10%1. Our high yield market weight is only around 15% of the entire Asian USD market right now.2”
But Hui points out that this challenge also creates an opportunity. “As global credit investors have become less active in the high yield Asian credit market, there are some very interesting opportunities for us to cherry pick. If we manage this properly, we can generate some alpha from it.”
Lower correlation
Meanwhile, the Asian credit market also faces second order effects from tighter financial conditions and increased risk aversion following the issues in the US banking sector.
Even so, Hui points out that the correlation between the US and Asia markets is lower than in the past. This is in part due to the fact that China, the largest banking sector in Asia, has only limited US dollar exposure. The local bond market, particularly in China and Singapore have also developed significantly in the past years, Hui explains.
“The Federal Reserve needs to strike a balance between tackling high inflation and managing financial stability in the banking sector. It is still a very fluid situation but it has become quite clear that the Asian market has lower correlation than we have experienced in the past, and that makes the Asian market very interesting this time around.”
Hui believes Fullerton is in a strong position to manage the various challenges thanks to its experienced Asia fixed income team. “Most of the team went through the global financial crisis and quite a few of us went through the Asian financial crisis. We also have a strong team in the FX and local rates market, and an experienced credit research team, which helps us identify interesting alpha opportunities.”
Looking ahead, Hui says Fullerton will be focusing on high quality issuances and maintaining a diversified portfolio, as well as being forward looking to manage risk.
“There will be volatility this year, and interest rates will be higher. We need to be agile and adapt to this environment and having a strong team that can work very closely with each other gives us an advantage. US Treasury bond yield is high and there is a dislocation in the credit market, and that should give us a lot of opportunities.”
1 Source: Bloomberg, as at April 21, 2023.
2 Source: Bloomberg, as at April 21, 2023.