Amid a challenging 2020, Asian fixed income turned in a resilient performance.¹,² With the global spread of COVID-19 accelerating in the first quarter of 2020 leading to lockdowns, the pandemic roiled economies and financial markets. Asia wasn’t spared: The region’s GDP was expected to take a hit that surpassed even that of the 1997 Asian financial crisis; however, North Asian economies contained the outbreak better, with many expected to post positive growth in 2020 (such as China, Taiwan, and South Korea). With significant monetary and fiscal stimulus, however, the region’s economies and financial markets gradually recovered over the course of the year.
Entering 2021, we believe that Asian fixed income can continue to perform on the back of a supportive global backdrop and continued policy support. With better fundamentals than its peers, we feel the asset class is poised to experience some potential upside, anchored to Asia’s resilient credit profile as well as emerging multi-year sustainable investing opportunities in Asia.
2020: resilient performance amid a sharp downturn
Despite the notable challenges of the past year, the fundamentals of Asian fixed income stayed intact; the asset class remained resilient throughout the year, delivering positive performance. During the first quarter of 2020, the J.P. Morgan Asia Credit Index (JACI) corrected around by 8% to 9% (to the trough), as the pandemic dented global financial markets.
The asset class also exhibited a lower drawdown relative to U.S. credit markets. As more global monetary and fiscal stimulus came into place, the Asian credit market experienced a sharp but steady rebound of about 12% (from its lows) toward the end of 2020. Indeed, the aggressive interest-rate cuts and market stimulus provided by the U.S. Federal Reserve provided some cushion to the markets, while Asian central banks followed. Most Asian currencies also stabilized, strengthening on the back of a weaker U.S. dollar as the global rush-to-safety capital flow receded.³
Source: Bloomberg, as of November 20, 2020.
Understandably, the pandemic’s impact on credit markets varied across different markets and industries, leading to an increasing divergence in credit quality. That said, the region is in a relatively better position due to the unique structure of the JACI, where a majority of its constituents enjoy an investment-grade rating, with many state-owned enterprises and quasisovereign entities benefiting from having a diversified range of funding channels, including the local banks and bond markets.
In the high-yield space, while defaults have indeed ticked higher, the impact has been less pronounced than initially feared:⁴ For instance, full-year default forecasts for Asian high yield have been revised lower from 4.0% in July to 3.0% in October.⁵ Furthermore, the region has so far only seen about 1.4% of investment-grade credits turn into fallen angels—only marginally higher than the 10-year average at 1.2%.⁴
2021 outlook: limited fallen angel risks for sovereign and quasisovereign
The more favorable macro landscape in 2021 should be constructive for Asian fixed income. We’re positive on the broader Asian fixed-income landscape given resilient credit fundamentals, continued accommodative monetary and fiscal policy, and downward pressure on the U.S. dollar. As mentioned, as a result of aggressive rate cuts and unprecedented balance sheet expansion by global central banks, more developed-market government bonds have become negatively yielding.⁶ In the event of tail risk event such as the U.S. Treasury yield turning negative (potentially due to a delay in the distribution of vaccines or a persistent deflationary environment), we could see a major asset rotation take place among investors, driven by the ongoing search for positive yields—Asian bonds could stand out given their sound fundamentals.
Overall, we expect defaults to remain reasonably contained in the first half of 2021 before we see an improvement in the second half as vaccines are rolled out globally, and Asia’s U.S. dollar bond market is ready to refinance issues, which are conducive to improve risk sentiment. Having said that, credit selection will remain key in Asian markets, as the recovery is expected to be uneven across countries and sectors.
China’s impressive economic recovery should continue. Real GDP growth for China is forecast to accelerate from 2.0% in 2020 to 8.2% year over year in 2021 before falling back to trend growth (5.0% to 6.0%) in the following year.⁷ Based on the optimistic view that the rollout of vaccines will help to support a return to global growth and drive broader economic recovery in China, we could see China withdraw some of the highly expansionary credit and fiscal policies that were implemented in 2020. Policy rates are expected to remain relatively stable as the People’s Bank of China has consistently signaled that it’s against excessive stimulus. It’ll likely continue with targeted monetary policy actions that could include more targeted reserve ratio requirement cuts as well as open market operations to manage market liquidity.
China bonds stand out in the current market cycle, relative to other global bond markets, due to the high nominal/positive real yields and diversification opportunities they offer. In the current macro environment and credit down cycle, we believe capturing the most attractive income opportunities with credit selection is key.
As 10-year China government bond yields have now moved back to around the 3.3% level, we believe this could be appealing to investors.⁸ From a yield curve perspective, the 5- to 7-year segment looks particularly attractive compared with longer-dated paper in terms of relative value. We believe the renminbi will stay broadly around current levels with the potential to appreciate further against the U.S. dollar, targeting the 6.40 level in the first half of 2021, after appreciating against the U.S. dollar by 6.0% in 2020. This is driven primarily by the softness in the U.S. dollar that may weaken further on possible delays to the U.S. economic recovery. We remain focused on systemically important state-owned enterprises that are also less reliant on the United States from both an operational and funding perspective. Domestically concentrated sectors such as utilities, property, telecommunications, and media are also areas of focus.
The tail risks stemming from continuing U.S.-China tensions will likely persist—especially given recently passed legislation authorizing the potential delisting of U.S.-listed Chinese firms. Separately, we see increased tolerance on the part of Chinese regulators to orderly allow some bondholders to take losses, particularly for less strategically important state-owned enterprises.
Turning to Indonesia, the country arguably suffered the most economically among regional markets, posting its first negative year-over-year growth and technical recession since the Asian financial crisis. In response, the Indonesian government and Bank Indonesia released unprecedented levels of stimulus, including the use of debt monetization. These unique policy tools helped to boost economic growth and maintain confidence in the country’s credit markets. At the sovereign level, its current credit ratings (BBB, stable outlook by Moody’s and Fitch) provide the country with an ample buffer against being pushed below investment grade. The credit metrics of major quasisovereign corporates and leading banks in the country remained resilient, with adequate liquidity, making them well positioned to retain their investment-grade ratings. Although the Indonesian rupiah experienced a volatile 2020, it’s potentially poised for more stable performance in 2021 on the back of the country’s stronger economic prospects—this is despite the nation’s reliance on external debt. Within the high-yield space, quality high-yield issuers with adequate liquidity and decent corporate governance appear well positioned.
For India, fallen angel risks are on our radar as bank nonperforming loans are expected to rise to double digits over the next 12 to 18 months.⁹ However, these risks are mitigated by the improvement in COVID-19 containment (e.g., a 69% decline in active cases since mid-September¹⁰ compared with an increase in the rest of the world) and its resilient financials sector metrics. This would be supportive of a macroeconomic recovery in 2021. From a fiscal policy perspective, India has increased debt to support the economy. However, despite having a debt-to-GDP ratio approaching 90%, we’re less worried because external debt only comprises about 20% of India’s GDP,¹¹ which is considered to be at the lower end of the spectrum among emerging-market economies. In India, national champion state-owned enterprises are likely well positioned, as well as renewables with strong parent supports.
This theme of careful credit selection also extends to a major emerging opportunity—environmental, social, and governance (ESG) investing.
Emerging opportunities in Asian sustainable bonds
Although Asia arguably emphasized ESG factors later than other regions such as Europe, recent trends show momentum and optimism for investors in the space. With China, Japan, South Korea, Hong Kong, and New Zealand committing to becoming carbon neutral,¹² other governments are likely to follow, as such, we expect to witness a greater number of green bond issuance in the region. Global green bond issuance grew 12% in 2020 compared with the first nine months of 2019 and the global trend is supportive of further growth in the green and sustainable-labeled bond segment.¹³
Another reason why investors should favor opportunities in this space is the ability to generate genuinely holistic returns beyond traditional financial metrics. Outperforming benchmarks is more multifaceted than simply looking at the differences in returns—it also includes ESG factors such as carbon intensity, the ability to provide aging population support, and/or stronger governance structures. If a certain sustainable portfolio matches the benchmark, but does so with significantly less carbon emissions, this could support climate objectives. Even from a strict financial returns perspective, research and evidence suggest sustainable investing doesn’t compromise returns.¹⁴ For instance, the cumulative risk-adjusted return for the J.P. Morgan ESG Asia Credit Index from December 2012 to November 2020 is on par with the JACI. From a carbon-intensity perspective, JACI’s constituents emit nearly 420 tons of carbon dioxide (CO2) for every US$1 million of sales generated. In contrast, constituents of the J.P. Morgan ESG Asia Credit Index emit only 196 tons of CO2 per US$1 million of sales.
Source: Bloomberg, as of November 30. *Carbon-intensity data sourced through Trucost ESG analysis. Carbon intensity refers to Scope 1 and Scope 2 tons CO2 equivalent emissions per million U.S. dollar revenues.
This reinforces our belief that sustainable investing can enhance returns going forward, and issuer performance on ESG-related matters will likely resonate with investors who are concerned about sustainability. More importantly, impending changes to regulation coupled with growing investor demand for sustainable solutions are likely to change relative performance drivers going forward. We also expect green and sustainable-labeled bonds to be held by established, longer-term institutional investors. This could establish a more stable investor base, which could help to reduce drawdowns and provide better risk-adjusted returns for the asset class.
In terms of specific ESG opportunities in Asia, investors should look for companies that will benefit from environmental or social trends, such as providing cleantech, that will help to mitigate climate change or demographic shifts. Besides environmental and social factors, investors should emphasize the importance of governance factors. From a governance perspective, investors should focus on companies with more independent and diverse boards while rejecting those with a history of mismanagement or opaque business models.
All in all, we believe Asian fixed-income portfolios shouldn't only consider ESG risks, but actively take advantage of the ample ESG opportunities. While 2020 was an important year for ESG in Asia, we expect 2021 to be even more significant as investors and companies explore innovation in this space.
1 Bloomberg, as of March 23, 2020. The J.P. Morgan Asia Credit Index (JACI) corrected by 8.79%, while the Intercontinental Exchange Bank of America U.S. Corporate Index corrected 15.14% over the same time period. As of December 23, 2020, the JACI had gained 12.32% from its low point. 2 Central bank websites, as of November 20, 2020. One-year medium-term lending facility rate is used for China; market participants use the one-year medium-term lending facility rate as a guide for the monetary direction of the People’s Bank of China. 3 J.P. Morgan Asia Dollar Index gained 3.7%, as of December 17, 2020. 4 Although defaults in the high-yield space have hit a record US$8.8 billion, robust issuance means the default rate has been kept in check at a mere 2.4%. The percentage of high-yield paper trading at distressed levels (below 70 cents on the dollar) has moderated from 14.0% in March to 2.0% in October 2020. J.P. Morgan, October 2020. 5 J.P. Morgan, as of October 2020. 6 Bloomberg, Manulife Investment Management, as of November 30, 2020. 7 Bloomberg consensus, as of December 2020. 8 Bloomberg, as of December 16, 2020. 9 For Indian banks, projected nonperforming loan ratios and credit costs have been revised downward and collection rates have spiked to 90.0% in October from just 50.0% to 60.0% a few months prior. 10 The Center for Systems Science and Engineering at Johns Hopkins University. 11 CEIC, yearly figure as of March 2020. 12 “Asian giants’ carbon pledges boost global climate action, says UN climate chief,” The Straits Times, November 4, 2020. 13 “Another bumper year sees green bonds push through the $1tn mark,” PV Magazine, October 6, 2020. 14 Bloomberg, November 30, 2020. Figures shown are in gross U.S. dollar terms. Past performance does not guarantee future results. Investing involves risks. The J.P. Morgan ESG Asia Credit Index tracks the total return performance of the Asia ex-Japan U.S. dollar-denominated debt instruments across the Asian fixed-income asset class, including floating, perpetual, and subordinated bonds issued by sovereign, quasisovereign, and corporate entities. The index applies an environmental, social, and governance (ESG) scoring and screening methodology to tilt toward green bond issues or issuers ranked higher on ESG criteria and to underweight or remove issuers that rank lower. Carbon intensity data sourced through Trucost ESG analysis. Carbon intensity refers to Scope 1 and Scope 2 tons CO2 equivalent emissions per million U.S. dollar revenues.
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