Market Views: Fixed Income
Outlook 2020: Asian corporate bonds
- Renewed global central bank balance sheet expansion provides a favourable backdrop for Asian corporate bonds.
- There are attractive credit investment opportunities across various sectors particularly those that will benefit from long term structural trends in Asia (and China)
- Chinese corporates are responding to a slowing China economy with more disciplined management of their finances and balance sheets.
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 keep weakening as the transition from a manufacturing-led to a domestic consumption and service driven economy continues. Policymakers will look to mitigate weakness in the property sector through targeted, city-by-city measures.
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
The ongoing slowdown of the Chinese economy is not all bad news. As a result, many Chinese companies have 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. Renewable power in India is a rising sector within the Asian credit market. 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.
Market consensus is negative on the China high yield industrial sector and we agree caution is warranted given the macroeconomic backdrop. But there are a handful of credits which enjoy positive fundamentals.