After a banner year of issuance, capped by a record $10.6 billion issued in January 2013, investors in Asian high-yield debt face a tougher environment.
“Income will dominate and capital appreciation will be limited,” says Bryan Collins, portfolio manager at Fidelity Worldwide Investments.
Tim Jagger, who manages Asian high-yield bonds at Aviva Investors, says that in contrast to the equity-like returns that investors enjoyed in 2012, this year they will only make money from the coupon of Asian high-yield bonds.
Julian Trott, head of debt syndication for Asia ex-Japan at Goldman Sachs, says 50% of those January deals are now trading underwater. He expects credit investors will return to high-grade instruments. “There will be more discrimination of high yield by investors,” he says.
Demand for Asian junk bonds will become more volatile, says James Su, fixed income portfolio manager at Sinopac Asset Management. “Spreads are compressing,” he says, due to improving prospects for economic growth in the region.
The amount of junk bond issuance has grown rapidly from a small base, with Asia ex-Japan issuance hitting $15.3 billion in 2012, according to Dealogic. However, country and sector choice remains limited, with Chinese property developers dominating the supply; this sector accounted for more than half of the January deal volume.
Quality among them varies: some, like Country Garden, have gone through the process of obtaining a credit rating and wooing US institutional investors. Others have not.
Trott says unrated borrowers offer little relative value to cross-border investors. “Many issuers are not used to investor scrutiny,” he says. “Their management is not doing investor relations meetings with bondholders, as they would do with equity investors.”
Su believes as more companies come to market, as they take advantage of low interest rates and seek to diversify funding away from banks, governance and investor relations efforts will improve.
And so far, the track record has been good. Todd Schubert, head of fixed income research at wealth manager Bank of Singapore, notes that some Chinese real estate companies have now built track records in the bond markets of up to eight years. “Disclosure is better, and there haven’t been any defaults so far,” he says.
Private bank clients have led the charge into Asian high yield, leaving real-money managers to play catch-up. Such investors have been willing to buy the bonds of unrated issuers and enjoyed total returns of 15-20% in 2012.
Institutional investors are keeping an eye on private-banking flows, as this is going to impact pricing. It is such money that is contributing to spread compression, and is generally believed to be more likely to bolt at the first sign of trouble. These views were aired at FinanceAsia’s recent Asia Pacific debt markets event in Hong Kong.
Demand is also emerging among regional financial institutions, including central banks and life insurers, which have to diversify out of their home markets and are comfortable taking regional credit risk.
Such flows have reduced the typical premium tagged onto Asian bonds, which used to cost as much as 5% but is now below 3% for many instruments.
This has global real-money managers wary of high-yield bonds. “The Asia premium is justified,” says Collins, “especially for high yield.”
He and other investors site concerns over lack of legal precedents for bankruptcies and workouts; question marks about liquidity; a total lack of legal assurance for lenders to mainland Chinese companies; the inability to predict recovery rates in the event of a default.
Although investors won’t say if they are now selling Asian high yield, Collins and Jagger agree that it’s good tactics to sell into a market when premiums compress, and buy when they widen.
Investors are not abandoning ship, however. They are sticking to more credible issuers, including in Chinese real estate, and looking for opportunities in emerging sectors such as Chinese industrials and regional financial institutions. They also are looking more closely at dim-sum bonds issued in Hong Kong, where factors such as covenants and credit ratings are easier to analyse.
The easy money of 2012 appears to be made, however: investors don’t express much enthusiasm for the asset class as a whole, nor for traditional high-yield borrowers in Indonesia and the Philippines.
