As the economic impact of the coronavirus rolls on, indiscriminate bond selling by investors has pushed Asian spreads outwards – arguably to levels that are wider than their fundamentals merit.
The JP Morgan Asia Credit Index currently offers a yield exceeding 400 basis points (bp) over US Treasuries – a level last seen in 2011 during the European Union debt crisis. The high yield credit component of the index has risen by 500bp to nearly 1000bp.
Strategists are warning that there could be more pain to come. And yet, spreads are so wide that they fail to reflect likely defaults. Bond defaults might need to exceed 15% of participants in the high yield portion of the index in order for it to offer negative annual returns, given its current 10% spread. The highest default rate seen in Asia over the last decade was 3.1% in 2015.
Of course, there's a reason why spreads blew out – there are expectations of many more corporate defaults to come, amid persistent difficult conditions. But will such defaults rise to terrifying levels, or do current spreads offer a major investment opportunity for long-term minded investors into Asia fixed income?
Six market experts shared their views with AsianInvestor.
The following has been edited for clarity and brevity.
Jim Veneau, Asia head of fixed income
Axa Investment Managers
At their widest levels, Asian single-B spreads were +1,755bp on a z-spread to worst basis, the widest level since the 2008 global financial crisis. They are now at +1,325bp, almost exactly the widest levels of the 2011 eurozone driven selloff.
Asia’s dollar credit market is much larger than 2008, with more issuers and a higher market cap. China is also the now the dominant country in the index, but the A1 rated country has the policy tools and stimulus to revive growth and support its economy.
Meanwhile, the US Federal Reserve has deployed unprecedented monetary tools, other major central banks have also acted forcefully, and major fiscal commitments are or will take place in an effort to prevent a Great Depression-like economic downturn.
Even if spreads widen further, the market is likely pricing in too much default risk. Currently 188 bonds in JP Morgan’s Asian Credit Index yield more than 10%. This is down from 301 at the end of March but still higher than the bottom of the market in 2018.
But investors should be careful if repositioning toward re-risking. They should gradually neutralise duration time spread (DTS) by adding oversold high conviction issuers (mainly short-dated China property bonds and telecom sector credits). In addition, they should continue to emphasise low spread duration and reduce high-beta single-B exposure in high yield strategies while shifting to investment grade (mainly oversold BBB-rated bonds) from high yield in crossover strategies.
Vanessa Chan, investment director
Widening spreads and price dislocation in Asian credit markets have been exacerbated by the unwinding of leverage that had built up. This has led to spread levels shifting back to 2011 Eurozone crisis and 2008 financial crisis levels.
There is now immense value to be had, while taking liquidity management and credit selection into consideration.
We will continue to monitor the Covid-19 situation and look for steps or signs of business and economic activity pick-up in Europe and the US. Volatility will likely continue in the short to medium term.
The Chinese property sector should be closely watched as it accounts for half of the Asian high yield market. Most of the higher quality and larger Chinese property developers pre- funded most of their maturities due in 2020, and some larger developers issued onshore bonds to take advantage of supportive liquidity due to China’s monetary easing bias.
However, some smaller regional property developers had tight liquidity before the virus outbreak and may see increased downgrade risk. The key for China’s property sector is the pace of recovery in property sales, companies’ access to alternative funding and government policies.
Elsewhere, Macanese gaming sector companies have completed most capex, have strong banking relationships and sufficient funding channels. Most will remain intact for next six to nine months.
Energy companies could feel pressure given oil prices levels, but most larger players are government linked and more established firms have good banking relationships, so should have no refinancing pressure in next six months.
The corporate bond market has priced in deep discounts, which could link up to the earnings outlook of affected industry sectors. Aviation carriers, the retail consumption sector and the tourism industry have seen their sales most seriously hurt by the coronvirus outbreak, and country efforts to limit its spread.
Central banks around the world have started monetary easing and quantitative easing to support financial market liquidity.
We expect the combination of liquidity from monetary to fiscal policy actions should keep manufacturers and industries from serious operational failure. However, there could be rising cases in delinquency and non-performing loans.
Food, pharmaceuticals, chemicals, internet, and consumer staple credits could be star performers in the coming six months. They have seen spreads widen by 200 to 500 basis points and are worth looking at for mid to long-term value investments.
In contrast, the risk factor of weaker crude oil prices has affected oil-related corporates even more than Covid-19. However, upstream players still have financial buffers and the decision on crude oil supply at the next Opec meeting could help to reprice deeply discounted investment grade quality credits.
Looking ahead, this is the best time to lock in yields, with global interest rates set to remain at historic lows for the foreseeable future. Asian high yield corporate bonds with 8% to 10% yields look attractive and regional credits look defensive versus other emerging markets.
Charles de Quinsonas, deputy fund manager in the fixed income team
We expect emerging market high yield default rates to pick up to mid-single digits in the next 12 months but this crisis is different from previous ones and it’s hard to call the timing and the shape of the recovery.
When it comes to regional relative value, Asian high yield bond spreads have not widened as much as Africa or Latin America high yield but we do not expect default rates to reach high single digits in Asia while it may be the case in other regions due to sector concentration or sovereign contagion.
We find good pockets of value in the Chinese property market and India high yield after the huge repricing in March. In China, outside of Wuhan there are signs that construction has resumed and month-on-month contract sales numbers are encouraging. Many Chinese developers also have prefunded liquidity needs in 2019 and in January 2020, therefore liquidity profiles are actually manageable in general.
In India, the macroeconomic environment is weighing on the corporate bond universe and many bonds plunged by 20 to 25 points in March, reflecting the uncertainties due to the Covid-19 outbreak and the commodity sell-off. We still find value in selective renewable companies as well as telecom bond issuers.
In the cyclical space, we prefer to avoid single Bs and favour BBs where valuations have overshot. We continue to be cautious on Indonesian high yield companies due to fundamentals.
Paul Lukaszewski, head of corporate debt in Asia and Australia and head of emerging market credit research
Aberdeen Standard Investments
Following the historic selloff of March 2020, Asian high yield spreads imply a default rate over 10%, equivalent to what was seen in 2009 following the global financial crisis. The Covid-19 crisis will be a leveraging event for corporates and will result in a default cycle.
The economic shock resulting from the pandemic will exacerbate existing problems and imbalances. Issuers entering the crisis with weak balance sheets will struggle to survive.
We already see acute levels of stress. Transportation is severely impacted by broad travel restrictions, retail and leisure are affected by shelter-in-place orders, energy is under severe stress due to the collapse of oil prices, etc. Big unknowns remain about the breadth and depth of containment measures required to end the spread of the virus.
The lack of strong global coordination raises risks that subsequent hot-spots will arise, possibly requring further cycles of containment rather than a steady recovery. Across the globe, ratings agencies have begun aggressively downgrading issuers in anticipation of the upcoming credit cycle.
In the face of this uncertainty and fear, investors with capital to deploy should take advantage. With a 10%+ default rate priced into Asian high yield, substantial downside is reflected in asset prices. These are the most attractive entry points for over a decade.
Astute investors will capitalise on this opportunity, distinguishing issuers with strong balance sheets and ample liquidity who will weather the storm. Opportunity is plentiful for those in a position to capitalise on it.
Markets are facing significant near term challenges as Covid-19 continues to spread globally. The economic impact and timeframe is still hard for investors to quantify.
In addition, the ongoing oil price war will create substantial volatility and pressure for financial markets. High yield markets in Asia haven’t been immune, and since the start of the year we turned to an increasingly cautious near-term view, believing the global reaction to the crisis in China was too slow and could cause a spike in volatility.
We are now increasingly optimistic on Asian high yield bonds as spreads are trading at attractive levels and substantial policy support has been added around the world. The Asian credit space is also supported by a relatively better regional outlook in the second half of 2020.
It is worth reiterating Asia's fundamentals. While default rates have risen, regional high yield companies are relatively better placed to service their debt compared to other emerging market economies. This is partly due to lower commodities exposure.
In addition, as rates head into 'lower for longer', demand for Asia high yield will continue to be strong as investors search for yield. Investors can add credit selectively as many sound companies are now trading with very cheap valuations.
So far, we have maintained a good record of managing our Asian high yield strategy in strong credit markets and the current liquidity-challenged period. We continue to monitor high yield liquidity conditions very closely.