Fidelity's bondholder activist cautions yield chasers

Fidelity portfolio manager Bryan Collins gives his views on the risks involved in the search for yield and why Asian investors are looking to their own backyard.

Bryan Collins, a portfolio manager at Fidelity, is one of the more vocal fund managers within the industry, whether it be taking on companies seeking to loosen bond covenants without sufficiently compensating investors or expounding on the risks of corporate hybrids. In this interview with FinanceAsia he talks about the fundamentals supporting Asian high-yield bonds and whether investor protection has improved.

We’ve seen record dollar bond issuance in Asia so far this year; do investors have the appetite to sustain that level of issuance?
The strong issuance we have seen year-to-date is, in part, a reflection of a few things. For one, during the latter part of last year, the dollar markets were closed as a result of big de-risking concerns about Europe, the US and China. We did not get a lot of issuance that we normally would have had and so some of the issuance we are seeing this year is a catch-up from last year. The total issuance we have seen year-to-date is almost equal to all the issuance in 2011.

Secondly, we have seen a lot of opportunistic issuance from Hong Kong conglomerates that want to diversify their funding base away from banks; part of a broader disintermediation theme happening across global capital markets to take advantage of what issuers see as low nominal rates. We have also seen more issuance from Chinese state-owned enterprises looking to diversify their funding base and move offshore. There has been a healthy mix of dim sum and dollar issuance but I think it would be difficult for the market to continue to absorb issuance at the pace it has been going, just because the run rate is quite high.

However, we have seen more Asian dedicated investors participating in the market, which is a good thing. It helps to have dedicated funds allocating to Asia, but it is important to make sure that the types of credits coming to market are good as well. I was reasonably encouraged that there was a pushback from the market when a couple of the single-B rated names tried to come to the market a month ago. It was a pushback based on pricing, credit quality and other issues. It was good to see that the investor community in Asia is not so flush with cash that they are falling over themselves in search of yield at any cost. There was an element of discerning credit opinion and, as a result, those deals struggled to come to market.

How has the investor base changed?
One of things that is different from 2006 and 2007 (when we had a liquidity-fuelled boom in the market) is that, then, we had a lot of funds invested in Asia, but most of them were US- or European-orientated global funds, emerging market funds or broader macro and even leveraged funds. We saw a lot of that capital leave Asia. The trend we are seeing in Asian credit now is similar to what we saw in Asian equities in previous years. During the past few years, we have had more investors based in Asia wanting exposure to Asia, whether it is for yield or income. This includes institutional investors, high-net-worth individuals and retail investors, from some of the bigger domestic markets such as Hong Kong, Taiwan and Japan. It is also a reflection of people being a bit more wary of Europe. In fact, even European investors are wary of their own universe and so we have seen a renewed interest in Asia over the past few years. More importantly, the wealth that is accumulating in Asia is thinking more about its own backyard and I think that is a positive development, because for Asia credit to grow and develop as an asset class, we need to have a natural buyer base whose home bias is Asia. In the years gone past, we never quite had that.

China high-yield has struggled to make a comeback this year; do you expect that to change?
I do actually. When you look across the Asian high-yield space, I see value in China high-yield bonds. But there are a few things in the China space that we need to be mindful of. We are likely to see more issuance, especially for investment-grade bonds. In the high-yield space, we may not see that much new issuance so there may be some scarcity value.

Most importantly, as we see some of the easing measures from China come through and feed through into the second half, this will highlight where there is some real value, particularly for some of the single-B Chinese high-yield names. We have come to the end of the tightening cycle in China and that will feed through to some better numbers. The direction is clearly towards easing. The People’s Bank of China recently cut rates and gave unprecedented flexibility to Chinese banks to raise their deposit rates and reduce their lending rates. This has quite significant implications for interest rate liberalisation. The climate for a lot of these Chinese high-yield companies is stabilising if not improving. That will help with valuations and sentiment.

A lot of weak credits and covenant-light packages came to the dim sum market last year, but those types of borrowers have found it harder this year. Has investor protection in the dim sum market improved?
It has not deteriorated further, which is what is most important at this stage. We have been extremely vocal about the need to set standards and have an appropriate level of due diligence in the Asian credit space and specifically, in the dim sum market. We have been highly conscious of the weaker and more speculative credits that came to the dim sum market last year. Such credits were mispriced, had no covenants and were from companies we had never seen before with no meaningful track record and no ratings. During last September and October, when we had a large correction in the market, those credits re-priced to where they should have been.

As a result, for some of the high-yield borrowers looking at the dim sum space for funding, pricing is not attractive. Investors, particularly those who have been hurt, have also hopefully started to realise that they are not getting covenant protection or a credit rating. And with the market being so nascent and in its infancy stage, going down the credit spectrum at this point of time may not be the best of ideas. So there are a couple of reasons why we have not seen a lot of covenant-light and high-yield issuers coming through — principally, because of pricing and secondly because investors, I hope, are more cognizant of the risks.

Has there been any improvement in covenants for high-yield dollar bonds?
We have not seen any significant deterioration in covenants in the dollar space. The most recent covenant consent solicitation for an Indonesian telecommunications company was well communicated by the company and it was intrinsic to what they were doing as part of their business strategy. The company wanted to sell physical telco assets to lease them back, and release cash to reduce debt. This was something they had been communicating to investors for some time. They were well within their other covenants but they needed administrative consent from bondholders to sell the telco towers. That is perfectly fine. Otherwise we haven’t seen any recent egregious relaxation of covenants or companies trying to take advantage of bondholders by making big changes for small insignificant fees.


For more of Collins’s views see the July issue of FinanceAsia magazine.

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