Asian high yield: building resiliency amid volatility

Asian high yield (HY) has experienced a perfect storm of headwinds over the past two years.

The uncertainty began in August 2021 when the Chinese government released its unofficial Three Red Lines policy that fundamentally recalibrated the real estate sector’s role in the country’s economy by reducing the leverage levels of developers. The abruptly shifting commercial environment, coupled with strict COVID-19 lockdowns, strained developers’ cash flows and dented consumer sentiment. Without significant government support, this resulted in a cascade of defaults, credit downgrades, bond exchanges, and withdrawn credit ratings in the sector.

In 2022, global macro risks added to existing regional idiosyncratic ones as the U.S. Federal Reserve (Fed) undertook aggressive monetary tightening to curb surging inflation. The federal funds rate increased from a range of 0.00% to 0.25% in early March to a range of 4.25% to 4.50% by December 2022. As most developed- and emerging-market central banks followed the Fed’s lead, global fixed income posted its worst annual performance on record back to 1900. 

As a result, Asian HY bonds underperformed global HY peers in 2021 and 2022. However, the asset class sharply rebounded in November 2022 along with the announcement of China’s economic reopening and the release of supportive policies for the property sector.

Despite recent market volatility, we believe the outlook for Asian HY in 2023 remains broadly constructive in an admittedly challenging environment due to the region’s economic resilience and the unique characteristics of the asset class.

Asia is poised to weather challenges in 2023

In our 2023 Asian Fixed-Income Outlook, we posited that most of the unprecedented headwinds facing fixed income had likely passed, although we didn’t see a significant improvement in global macro conditions. Indeed, much of the monetary tightening needed to contain inflation had already been priced in and the trajectory of future Fed policy was less certain (i.e., higher rates over a longer period).

At the same time, we believe Asia is better positioned than other regions to navigate the current complex macro landscape for two reasons.

First, Mainland China’s decision to abolish its zero-COVID policy and reopen its economy has progressed at a faster-than-expected pace. The International Monetary Fund (IMF) upgraded the country’s 2023 GDP forecast to 5.2% in late January, which should pay dividends for its neighbors with notably positive spillover effects. For example, Thailand recorded a near-16-fold increase in year-over-year tourist arrivals in January 2023, with the number of Chinese tourists rising by roughly 80.0% from the previous month (during the country’s peak season). 

Second, this reopening dynamic dovetails with existing regional economic strength and a more favorable inflation outlook. The IMF forecasts that Asia-Pacific will grow by 4.7% in 2023—a notable acceleration from 2022—and the fastest regional rate in a decelerating global economy.

Inflationary pressures are also arguably lower overall and uneven across the region, leading monetary policies to diverge from developed markets (except Japan). Due to its delayed economic reopening, Mainland China has adopted a countercyclical rates policy, evidenced by the People’s Bank of China’s recent decision to make a reserve requirement ratio cut for all banks. Other markets such as Indonesia, Malaysia, and South Korea have paused monetary tightening, with India contemplating to do the same as inflation moderated. 

The advantages of Asian HY

In addition to potential economic tailwinds, the asset class possesses several key advantages over its global peers.

Shorter duration profile and higher yield-to maturity

The Asian HY universe traditionally boasts a shorter duration profile, or bond price sensitivity to movements in interest rates, relative to its global peers.

Asian HY currently boasts shorter duration (2.69 years) compared to HY in the United States (3.92 years) and emerging markets (4.38 years). It also potentially offers yield pickup for investors as the region has, on average, the highest bond yield levels since 2011.¹

These characteristics add to the overall attractiveness of Asian HY, which has outperformed regional investment-grade bonds in 10 out of the last 17 calendar years (2006 to 2022).¹ In light of current volatility in U.S. rates, the asset class is well positioned as it typically trades more on changes in credit spreads than interest rates. Put differently, the correlation of Asian HY to 10-year U.S. Treasuries is relatively low. ¹

Decelerating default risk

After a tumultuous 2022, which saw the highest default rate among Asian HY credits in over a decade (16.5%), defaults are forecast to significantly decelerate in 2023 to 4.1%.² This is largely due to the region’s overall economic health as well as policy support and improvements in Mainland China’s property sector.

At the same time, HY defaults are expected to increase in the United States and Europe, trending toward the historical average amid slower growth and higher interest rates.

Diverse, less concentrated investment universe

The asset class also offers an increasingly diverse, less concentrated investment universe, which has accelerated with the removal of some Chinese property firms from major credit indexes.

Indeed, while China real estate composed around 39% of the J.P. Morgan Asia Credit Index (JACI) Non-Investment Grade in December 2020, it has contracted to roughly 16% by February 2023 due to defaults and index removals.³ This offers investors new opportunities in less concentrated sectors.

The changing issuance landscape and increased borrower diversity are punctuated by the range of economic models that compose the region, which is unique for emerging-market debt. Asia features economies that are more dependent on manufacturing and exports, particularly in northeast Asia. The region also features markets that are rich in natural resources and high in domestic consumption (Indonesia), and the export of services (India, which is quickly building its manufacturing capacity).

2023 outlook: China credits and Indian renewable energy

Looking ahead to the rest of 2023, we’re positive on selected China credits (including property) and Indian renewable energy.

China property: The sector rebounded strongly at the end of 2022 and the start of 2023, buoyed by new government support measures and optimism about the country’s economic reopening.

In light of recent notable gains, we remain constructive on certain credits but are far more selective. In our view, further upside should be dependent on improving market sentiment and continuing targeted government policy support.

• Evidence of improving market sentiment
  

Early signs indicate a nascent rebound in home sales and property prices, which remain a crucial driver of improving consumer sentiment and cash flow among struggling developers.

After 19 consecutive months of decline, the monthly sales of the country’s top 100 real-estate developers rose by 14.9% in February and surged by 29.2% in March (year on year). National new home prices in 70 cities ticked higher by 0.3% (month on month) in February—the first increase in 18 months.

While it’s still too early to call a turnaround definitively, the improving sentiment should be welcomed by investors.

• Increased policy support amid restructuring progress for creditors
  

A lack of timely and effective government policy support for the property sector was a key factor that dented investor sentiment.

This dynamic changed in November 2022 with the introduction of the comprehensive 16 Measures, which aimed to boost sector liquidity and ensure the completion of unfinished property projects. Ex-Premier Li Keqiang built on this momentum by promoting the sector’s stable development as a key goal for 2023 during the recently held National People’s Congress (NPC).

The restructuring of offshore credit defaults in the property sector had been slow but is gaining momentum. This is an important milestone for investors to monitor because how companies treat and compensate creditors could be used as a proxy for further investor participation in the sector. One of the most significant offshore defaults that occurred in late 2021 announced its long-awaited restructuring plan in late March. Meanwhile, another leading property developer announced that it had reached a tentative agreement with 30% of offshore bondholders to restructure its debt. 

China credits: We remain constructive on sectors such as industrials and consumer discretionary (e.g., gaming), which should benefit from accelerated economic growth. We also believe that domestic credits should benefit from recent announcements at the NPC, such as  initiatives aimed at promoting greater economic efficiency through a reduction in the size of the State Council and the creation of a new central commission for science and technology. 

India renewable energy: Outside of Mainland China, we’re still positive on India renewable energy. These credits are part of a growing investment universe and can provide diversification—India’s growth cycle has a relatively lower correlation to the rest of the world—and continued government support for renewables, as seen in the recently released Union Budget.

Credit selection remains critical

Finally, despite the potential regional tailwinds and advantages of Asian HY that we’ve detailed so far, robust credit research and selection remain critical in the current volatile market environment.

Conclusion

After two years of underperformance, we believe Asian HY presents compelling risk/reward opportunities for investors. In addition to the region’s economic strength, the asset class’s unique characteristics, such as a shorter duration profile, position it well to perform in a higher-for-longer rates environment relative to its peers. Manulife Investment Management possesses unique resources for robust bottom-up credit assessment to help investors navigate the current volatility and seize opportunities available in Asian HY.

1 Bloomberg, as of March 31, 2023. 2 J.P. Morgan, as of February 2, 2023. 3 J.P. Morgan, as of February 28, 2023.