2018 was one of the most disappointing years in recent times for the Asian high yield bond market outside of Japan.
Despite enjoying a decent start to the year, the market started suffering as soon as the second quarter kicked off, hit by a double-whammy of expectations for higher US interest rates and concerns over escalating global trade tensions.
Throughout the year, average dollar bond yields in the high-yield market widened from 7% to 9%. Subdued demand led to a sharp decline in supply of new high-yield bonds after April, and the market remained largely muted for the rest of the year.
One silver lining is that the high-yield Asian bond market ex-Japan now boasts the highest returns since the 2008 global financial crisis.
David Tan, chief investment officer of Asia-Pacific for fixed income at Allianz Global Investors, spoke with FinanceAsia about opportunities in the high-yield market this year.
This interview has been edited for brevity and clarity.
Q Why do you think it is now a good time to increase exposure in the Asia ex-Japan high-yield market?
A Asian US dollar high-yield credit is trading at attractive valuations after the selloff last year, offering compelling returns for investors seeking long-term high income.
Inflationary expectations have dampened on the back of falling oil prices, leading to a more dovish trajectory for US rates.
And while that suggests economic growth is slowing across markets, we see supportive fiscal and monetary policies being implemented by central governments. Therefore we do not expect a recession to occur.
Q Is it now a better time for Asia corporates to refinance themselves?
A Yes, from an issuer's standpoint. High-yield supply was cut-off when demand was low last year, but this year we have already seen a strong start particularly from the Chinese property sector.
From an investor’s perspective, however, we still need to be careful to select the right issuers.
Q Corporate defaults in the high-yield space appear to be rising. Is that a concern?
A It is true that high-yield default rates in the region have risen throughout 2018 but they are still at a healthy level of 2.5%, compared to 3.5% for European emerging markets and 3.4% for Latin America.
Overall, Asian credit fundamentals remain broadly stable and we do not expect any wide-spread systemic risk in the high-yield sector.
Q How do you plan to adjust your portfolio strategies this year?
A We preferred short-dated bonds last year but we are switching to longer-dated ones. We plan to extend the average maturity of our high-yield bond portfolio for a year to about three years.
Q Which sectors do you overweight and which do you underweight?
A We particularly like Chinese property. We also selectively overweight commodities in emerging markets, like Indonesia and India. We underweight industrials.
Q Why are you bullish on Chinese property?
A Our house view is that the US dollar might have peaked at the current level, suggesting the Renminbi will be stronger against the dollar. A strong RMB is beneficial to Chinese property developers because their sales revenue will appreciate against their offshore debt.
Q But there are also a lot of onshore bond defaults in the Chinese property sector.
A The number is huge, but it actually accounts for just 0.76% of the onshore bond market. There is also not much spillover into the offshore dollar bond market.
China’s property sector accounts for about 15% of the country's gross domestic product. If we include other related industries, that may go up to 20% or 30%. We think the government understands the importance of maintaining a stable real estate market while it deleverages its economy.
That said, we believe there will be a divergence of performance among property developers. We will focus on rated developers with strong sales execution capabilities and those with good access to funding.
Q What about local-government financing vehicle bonds? The sentiment appears to have cooled off since the beginning of last year.
A It is important to view LGFVs as corporates and focus on the business itself. We also prefer LGFVs that have strategic value to the local economy or a particular industry.