A good year for Asian high yield, but what’s next
Asian investment grade and yield enhancement products are likely to be in demand with a potential global economic slowdown looming
31 Oct 2019 | Aaron Leung
While high-yield bonds were popular with investors in the first half of the year, mounting uncertainties suggest a change in tack will be necessary going forward. “The hunt for yield is definitely supportive, as it helps borrowers via a lower cost of funding. However, investors will still be worried about increasing default probabilities, which will make them cautious towards high-yielding credits in an environment of slowing global growth,” explains Shankar Narayanaswamy, head of sovereign strategy (East), Standard Chartered Bank.
In a survey of more than 300 of the region’s top ranking sellside individuals conducted by Asset Benchmark Research (ABR) in September, the prevailing view was that the default rate would increase.
“As a result of the economic slowdown, we foresee weaker commodity prices, a deteriorating operational environment and tougher China onshore refinancing channels,” one trader comments. “I expect the default rate to be slightly higher than last year at between 2.8% and 3%.”
Another trader has a more pessimistic view of a 5% default rate. “China has not had a meaningful correction for 40 years, so if all bad conditions happen all at once (trade war, China deleveraging, US and European economic recession), the corporate default rate could skyrocket, to unforeseen levels.”
Similarly, a Hong-Kong-based salesperson thinks the default rate could be either 0% or in excess of 10%. “No one wants to be the first one who is blamed and punished, but after the first default, no one would really care about the second or those that follow,” he reasons.
However, many suggest that the regulators will manage the situation to ensure that any default would be a one-off event and not a systemic crisis. “In event of a sharp economic slowdown in Asia, I do not expect the default rate to spike up significantly as I reckon governments are ensuring liquidity is made available to corporates. In the oil crisis in 2015, the default rate went to about 3.1%. So I expect the default rate to probably be around 3% if there is a sharp economic slowdown in Asia,” one salesperson says.
A trader echoes this sentiment: “Historically the default rates in Asia have stayed very low, even to some extent artificially so. I don't see that changing drastically as negative news would only make the stimulus/policy support grow stronger and given a lot of debt in Asia has some sort of PSU/SOE halo, it should get some sort of protection.”
In this environment, there has been a general trend toward investment grade and structured products. A Hong Kong salesperson expects his clients to be “searching for yield, downside protection or capitalizing on a downside view via “high-quality long bonds, AT1s, sound fundamental high-yield credits that are not directly impacted by the tariff war, minimum redemption notes, equity bearish participation notes, XAU linked notes and deep strike equity fixed coupon notes.”
But different investor types will have varying requirements. “I expect private-bank-type clients to be more open to structured transactions, which give yield, given the expectation that rates are likely to remain low with central banks in easing mode globally,” says one Singapore-based salesperson. “Real money and/or hedge fund clients are likely to be more involved in derivatives for hedging and/or accessing the onshore bond market.”
Another salesperson echoes this sentiment: “We'll see a pick-up in volatility. More and more investors (both fast money and real money) signed ISDAs over the past three years so the number of CDS players is significantly higher than before. CDS is a volatility product so we will naturally see a pick-up in demand in a high volatility environment.”
Multiple areas of concern hang over Asia’s bond markets. According to the ABR survey, the US-China trade war is the most worrying issue by a wide margin.
In another series of questions, top-ranking economists, strategists and analysts were asked which economic indicator is the most important in the current environment.
Since Chinese corporates dominate the outstanding issue of Asian USD credits, it is not surprising that most of the nominated researchers focus on leading indicators such as PMI, inflation, employment rate, and PPI. China TSF (total social financing) and onshore yield curve and USD-CNY movement are closely watched to help monitor the liquidity risk and financing cost.
Some economists are eyeing more specific figures such as home sales and land sales. As Ting Lu, China chief economist at Nomura, points out: “the property sector is being excluded from the previous round of policy easing, but the incoming slowdown of the highly leveraged property sector could have a big impact on the Chinese economy and may force Beijing to adjust its policy stance again.”
Another economic indicator is the inversion of the yield curve. Although the discussion of it seems to be less prominent in Asia than in the US, a few researchers considered it as an important indicator in the current environment. Manjesh Verma, trader with Citi, says: “The 3 month-10 year yield curve and 2-10 year yield curve are the most important indicators to be monitored closely if the inversion is being sustained or not.” 
Researchers were also asked what reassures them the most about the current economic situation. Above all, while the headlines of lacklustre economic growth seem discouraging, the policies of the central banks, are reassuring to the market.
On the investors’ side, most portfolio managers are holding a higher cash position. According to ABR’s Asian G3 Bond Benchmark Review, the average cash position of fixed income investors’ portfolio stands at 10.7%. Avanti Save, credit strategist at Barclays, confirms this, “fund managers are holding a moderate amount of cash; there will be a relatively high amount of bond redemptions in the remainder of the year.”
Asia, especially China, will still offer opportunities to fixed income investors. Anna Ho, credit analyst at UBS, comments: “China will still outgrow the majority of the world economies. The refinancing cycle is getting shorter but risk is still under control as credit quality is buffered i.e. larger players manage to survive and gain market share through industry consolidation.”
Mark Reade, head of fixed income desk research at Mizuho Securities, also predicts that Asia will remain an attractive market to investors in the coming “lower rate for longer” environment, “with the low-yield environment set to continue, demand for spread products (including Asian credit) should remain resilient.”
However, Asian high-yield bonds have already started to lose its attractiveness. A sales executive at a high-yield focused firm recalls: “products sensitive to US Treasuries such as investment grade bonds have been popular with the rally in Treasuries. Funds have been actively chasing duration on the back of this.…High-yield and EM bonds were popular in the first half of the year, but given the US/China trade dispute and uncertainty over global growth, they have lost their shine with investors.”
In the coming 12 months, the bond market trading will be driven by twin objectives: the need for safer assets and the hunt for yield. Eileen Wu, head of investor sales in Taiwan, predicts that “quality high-grade paper such as bonds issued by SOEs in Southeast Asia” will be one of the most popular products in the coming 12 months because of a “dovish Fed and upgrades of Philippines, Indonesia and Vietnam by S&P”. Thus, quality Asian high grade will be chased after as a “global and diversified asset class with its stable premium of 20bps to US HG”. 
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