Thursday, February 2

Asia high yield: A gem within the high yield universe

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Persistently low policy rates, braced by mounting risk sentiment have emboldened investors to venture beyond traditional safe havens and down the credit spectrum. Amongst the riskier debt segments, Asia high yield offers the most attractive credit opportunity and is our top pick for 2021.

Based on our Asia macro and earnings outlook, we expect lower stress and healthy fundamentals for Asia high yield issuers this year. We also hold a constructive view on China’s real estate sector, which should lay a positive backdrop for China high yield issuers.

Asia high yield provides strong coupon return, offering handsome yield pick-ups over peer segments. Valuation for the asset class remains cheap, with spread close to one standard deviation above historical average. We expect ample room for tightening, back to near pre-Covid levels, driving upside for price return.

Interest rate risk remains muted given lower duration and high yield per unit duration. Default risk is subsiding and will be manageable with current spread compensating well for undertaking such risk. We view risk premia offered by Asia high yield to be very attractive.

Asia high yield is one of our top fixed income pick for 2021 and current yield/ spread presents good entry opportunity.

Higher-yielding, riskier debt has been on a tear since late 4Q20. Expectations of a continuance in low policy rates, braced by mounting risk sentiment have emboldened investors to venture beyond traditional safe havens such as treasuries and investment grade bonds.

Amongst the riskier higher yielding segments, our preference remains tilted to Asia high yield (HY). The asset class was hit dramatically back in March 2020 (chart 1), when Covid-19 fears rippled from Asia, but has since underwent a rigorous rebound.

As we explore attractive credit opportunities in 2021, Asia HY stands out strongly given a multitude of favourable tailwinds and manageable risks (outlined in the following sections). Peering further into 2021, we believe the asset class can be a gem in the fixed income space.

Asia HY was hit hard back in March 2020 but has since rebounded valiantly

Asia HY offers the highest yield on a relative basis

Excellent yield pickup opportunity

Part of the allure for Asia HY, even over its HY peers, is its attractive coupon return. Most fixed income segments are offering paltry levels of yield, with many just a thread above their historical minimum.

In our view, Asia HY is amongst the best asset class to harness yield. Given a beefy yield offering of 6.6 per cent, coupon return easily best its fixed income peerand bond proxies. Despite drastic retracement in credit spreads since March 2020 and lately in November 2020, Asia HY’s yield is only marginally below its long-term average of 7.1 per cent.

The asset class also offers handsome above-average yield pick-ups over IGs and even HYs peers. Against the former, Asia HY offers a pick-up of 470 to 650 bps, and against the latter, it offers a pick-up of 90 to 350 bps. We view the decent pickup against other HY segment as significant because it meant that additional coupon return generated by Asia HY do not come at the cost of higher credit risk.

 

Cheap valuation and potential for further spread compression

Akin to equity markets, valuation (in terms of spread) is no longer cheap for most fixed income segments. Credit spread for HYs have retraced drastically, reflecting improving fundamentals as well as dissolving liquidity and default concerns. Despite so, we continue to find Asia HY to be one of the scant few that offers value.

On an absolute level, spread (631 bps) for the asset class is still hovering close to one standard deviation above historical average (Z-score of 0.7). While on a relative level, Asia HY offers the highest spread amongst all segments, with the highest Z-score when compared.

Credit spread tightening is an integral driver of return for HY assets – the wider the spread, the higher the potential returns over time. We hold the view that Asia HY spread will reprice lower this year as credit risks subside. Our believe is predicated by our Asia macro and earnings outlook, expectation of accommodative policy and demand meeting debt issuance (issuers able to refinance) in 2021.

With where spread is at relative to history, we see ample room for tightening (higher potential return). In our view, there is a good possibility that spread return to pre-Covid level (430 bps) over time, which would entail a handsome tightening of 200bps.

Yield pickup over both IG and HY are also substantial

Valuation for the fixed income space has turned expensive

Healthy fundamentals supported by Asia’s macro and earnings recovery

On a macro level, we expect Asia’s economic recovery, which accelerated in late – 3Q20, to hold steady in early 2021. The region’s growth remains well bolstered by robust exports growth as well as a confluence of positive cycle dynamic (tech and manufacturing upcycle). Based on our projections, growth in Asia ex Japan has recovered to pre-Covid levels and should see above-trend healthy growth in 2021.

The region should also see strong corporate earnings rebound 2021, underpinned by healthy macro recovery, supportive policy rhetoric and a relatively faster ‘normalisation’. Moreover, monetary policies across Asia should stay accommodative throughout 2021, perpetuating the low rates and easy refinancing, lending support to high yield issuers in managing maturities this year.

Given the region’s constructive macro, earnings and policy outlook in 2021, we expect lower stress and healthy fundamentals for issuers, alleviating credit risks in Asia HY moving forward.