Outlook 2020: Asian corporate bonds
2019 was a favourable environment for Asian credit investors. After experiencing a modest negative return in 2018, a combination of a rally in US Treasuries and credit spread tightening contributed to strong returns in 2019. It serves as a reminder that the credit market does not require a strong economic environment to perform.
The uncertain US-China trade relationship and weak macroeconomic data had a limited impact on performance. Only a small proportion of Asian companies comprising the hard currency credit universe have direct exposures to the US economy.
We think Asian credit will be driven by the following themes in 2020:
Global monetary policy continuing to dominate market sentiment and returns. With over $11 trillion of negative yielding debt globally investors will likely have to go further afield in search of income.
Technology disruption as well as environmental, social and governance (ESG) considerations will be key drivers.
Chinese economic growth will be soft as the transition from a manufacturing-led to a domestic consumption and service driven economy continues. Policymakers may look to impose targeted, city-by-city measures in the property sector.
Chinese credit remains a large source of opportunity in Asia. Before too long we see regional credit investors beginning to appreciate the yield and diversification benefits of onshore Chinese (renminbi-denominated) credit.
Asian companies becoming more prudent
Many Chinese companies started to recognised that their “leverage leads to growth” model is unsustainable. This combined with the major economies becoming more protectionist is dampening corporate appetite to take on more debt. Asian companies are showing more discipline around capital expenditure and a less aggressive approach to M&A, instead paying more attention to maintaining healthy balance sheets. We expect default rates to rise moderately from a low base, but a significant increase looks unlikely.
Loose financial conditions in developed economies will continue to support demand for Asian corporate bonds given the relative attractiveness of local currency Asian interest rates.
Increased demand for Asian local currency bonds will push interest rates lower, reducing the interest burden for Asian companies and supporting credit fundamentals.
Times are changing
However, unlike 2019 “lower hanging fruits” will be in shorter supply. Indiscriminately chasing yield with the assurance of a central bank back stop and governments (via implicit state support and state transfers), is unlikely to work in 2020.
Technological disruptions are no longer solely an equity market theme and have begun to have an impact on Asian credit issuers too. With virtual banks gaining traction, traditional banks will face pressures if they fail to innovate. Similarly, companies that fail to manage their environmental impact have already had trouble in raising debt finance. The Chinese authorities are encouraging companies to be “green” and China is now the second largest source of green bond issuance in the world.
After the last five years of market reforms, promising local currency Chinese credit opportunities are emerging in domestic consumption and service sectors. These are the areas best placed to benefit from the structural changes in China and many of these companies only issue local currency bonds.
Selective value in Asian high yield and property credit
After gains in 2019, the Asian credit market is hardly cheap. With attractive return opportunities hard to find globally, Asian credit is worthy of consideration but careful selection is needed.
We see value in China, particularly in high yield and property, with pockets of value in Indonesian and Indian high yield. Compared to the past few years, we think there will be greater divergence of performance in credit markets presenting security selection opportunities. We see high yield as more attractive overall. Asia should continue to see a healthy flow of first-time issuers, another source of potential selective value.
High yield in China is dominated by the property sector, and it accounts for over half of the Asia US dollar-denominated high yield market. Some investors seem uncomfortable with the regulatory changes in the sector, but we think they will help to contain systematic risks.
If credit investors focus on the property sector as a whole, they will miss the large dispersion between the sector’s 60 issuers. We see divergence within the sector continuing considering the different geographical focus, land banking strategies and execution capability.
We also think China presents some of the better opportunities within investment grade, as a lack of bond supply particularly from South East Asia has resulted in unattractive yields in other countries. Within investment grade, financials are likely to dominate new bond supply and present opportunities across the capital structure.
Within the semi-government hard currency corporate universe, we see some value in Indonesian quasi-sovereign issuers. On Asian hard currency sovereigns, we are cautious on frontier markets, such as Pakistan and Sri Lanka, due to high valuations especially when factoring geopolitical and fiscal risks.
Any security(s) mentioned above is for illustrative purpose only, not a recommendation to invest or divest.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Opinions stated are matters of judgment, which may change. Information herein is believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. Exchange rate changes may cause the value of the overseas investments to rise or fall. For risks associated with investment in securities in emerging and less developed markets, please refer to the relevant offering document.
The information contained in this document is provided for information purpose only and does not constitute any solicitation and offering of investment products. Potential investors should be aware that such investments involve market risk and should be regarded as long-term investments.
Derivatives carry a high degree of risk and should only be considered by sophisticated investors.
This material, including the website, has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.
- How climate change may impact financial markets
- What can investors do to better prepare for market opportunities and challenges?
- Johanna Kyrklund: is this the end of the beginning?
- Covid-19: Latest views on the Asian fixed income market
- Value investors: why are they so calm in a crisis?
- Coronavirus to spark “severe” global recession