As Covid-19 continues to rage across the world, Hong Kong-based insurer FWD has turned its sights on investment grade bonds instead of high yield corporate ones, and Asia – where it sees a lower risk of downgrades than in the US.
“There are plenty of quality Asian names that are often state-owned enterprises, so we don’t expect them to be downgraded to junk,” said Paul Carrett, chief investment officer of the life insurer. “Asian corporate bonds remain appealing subject to the name selection criteria we require,” he added.
“We don’t want to be holding names that could drop to high yield,” Carrett told AsianInvestor, noting that solvency requirements for insurers mean that a shift into high yield requires additional regulatory capital to be allocated against these bonds. That is on top of the loss of balance sheet associated with the falling value of the bond itself.
Asian investors continued to increase allocations into Asian investment grade corporate bonds in the first quarter of the year, adding $91 billion in net inflows, to a total of $885 billion in 2019, according to eVestment.
Carrett said he was cautious regarding BBB investment grade credits, where credit quality has fallen in recent years as investors increased their exposure to weaker companies in the search for yield. BBB rated bonds are worth $3.2 trillion in total, or 53% of US investment-grade corporate bond debt, according to S&P Global Ratings. A little less than a third of it is rated BBB-, the lowest investment-grade category.
“We’re looking at every name a lot more detail,” said Carrett. “In credit, this is a period that calls for active management – you have to be very carefully choosing your names.”
Managers in the US investment grade sector underperformed the Barclays US Corporate IG Index by -0.65% in the first quarter, during which the index fell 3.63% in the period. Kathryn Saklatvala, head of investment content at consultancy bfinance in London, said the underperformance resulted from managers owning a higher proportion of lower-rated names, which performed worse over the period.
In Japan, where FWD has yen liabilities to meet in its insurance business and so uses currency hedges, the falling costs of the currency hedge in recent weeks has been a valuable benefit to US dollar corporate bond investments, said Carrett.
“[Here] we buy foreign currency bonds and hedge to local currency,” he noted. “Buying dollar [investments] and hedging back to yen has come back materially: what used to cost us 2% now costs us 80bp [basis points].”
Stephen Chang, portfolio manager for Asia at Pimco, agreed that currency hedging has become a valuable source of return attracting Japanese institutional investors to US dollar yields in recent weeks. “Currency-hedged yields of US dollars into Japanese yen or euros are much higher than recent periods”.
HIGH YIELD CAUTION
Carrett said FWD was watching high yield closely, but he isn’t feeling compelled to commit meaningfully to this sector just yet.
“The Fed [US Federal Reserve] has definitely helped with liquidity in credit markets, but solvency is another matter. Given current dislocations, there will be opportunities for great managers, but we’re happy to be patient for now.”
Jim Veneau, Hong Kong-based head of Asia fixed income at Axa Investment Managers, told AsianInvestor in April that while the yield spread for junk bonds has surged, it was generally not sufficient to cover the higher capital incurred by the lower credit rating.
“Fallen angel credit spreads widen and prices drop, but [those bonds] are still relatively low-yielding compared to other high-yield names,” he said.
When Asian investors do buy high yield, they prefer Asia to the US, said Chang. “The US high yield sector is likely to experience more defaults given the weighting in energy and oil-related issuers, some of whom have already gone into bankruptcy,” he said, pointing to Diamond Offshore, the US oil firm which filed for bankruptcy on 27 April. He added that with Asia a net oil consumer, manufacturing and property companies have formed a higher proportion of indices.
The JP Morgan Asia non-investment grade corporate credit index spread (with Treasuries) peaked at 11.25% on March 23, and fell 8.22% by May 18, according to Bloomberg. The JP Morgan Asia investment grade corporate credit index peaked at 2.73% on March 24 and narrowed to 2.57% on May 18.
To learn more about how FWD and other investors are considering the appeal of Asia's bond markets, look out for the AsianInvestor webinar on June 4: "A New Investment Era: Will Asian & HKD bonds win the race for resilience?". Click here for more details.