A housing complex in Tianjin. AFP.
Changing Asia HY landscape
Since 2021, the Asia HY asset class has changed tremendously with the vast number of defaults in the China property sector, bond redemptions via liability management exercises (LME) in Indonesia and growth in the Indian renewable energy sector etc. As per the JPMorgan Asia Credit Index (JACI), the total market capitalisation of Asia HY has shrunk from USD1.2t as of end 2020 to USD934b as of 3 Jul 2024.
Despite the smaller market size, the index is now better in credit quality and offers investors more diversified country and sector exposures. The proportion of “BB”-rated credits (the best in HY) has increased to 52% as of 3 Jul 2024 from 36% as of end 2020. The percentage of real estate bonds has also declined to 16% from 44% over the same period. Sector wise, we now have a more even distribution amongst Financials (26%), Real Estate (16%), Consumer (12%), Sovereigns (11%), Utilities (10%) etc. Geographically, we also have a more diversified representation, with the weight of China now lowered to 25% from 54% then. China remains the largest (25%), followed by India (17%), Hong Kong (17%), Macau (11%), Philippines (8%) and Indonesia (4%).
The Asia HY universe compares well against its Developed Markets (DM) and Emerging Markets (EM) peers, with lower spread duration, higher credit quality but comparable yield levels. The segment has also generated one of the best in total returns year-to-date (YTD). It returned a stellar performance with total returns at ~11% as of 5 Jul 2024, beating most of its peers. Frontier sovereigns and China property led the performance, while most other Asia HY also posted better returns than its DM and EM HY peers.
Easing default rates and moderating credit deterioration
Asia HY has benefited from benign default rates (vs past few years), policy driven rally from depressed levels, strong market technicals and positive idiosyncratic events. Although defaults could still stay at higher than historical levels, the market expects a slowdown in 2024 as weaker credits gradually exit the index.
We have seen some credit deterioration in HY issuers. Although downgrades have exceeded upgrades since 2Q21, the pace of ratings pressure has moderated and thus far, downward credit migration has been largely concentrated in China property/LGFVs and parts of Indonesia HY.
For several Indonesia HY issuers, liability management exercises, funded through domestic loans, have helped to repay or refinance bond maturities, driving performance as a result of the better-than-expected outcome.
Selected China property developers and LGFVs have also turned to domestic borrowings and/or asset disposals to help manage bond maturities.
Supportive market technical
Despite gross issuance picking up of late, overall net issuance remains negative. Most of the gross issuance are in South Korea IG and Financials segments, while the HY segment continues to shrink as domestic loans markets remain accessible at reasonable funding cost to these issuers.
The reduction in HY issuance has led to investors’ search for yield and in turn provided technical support. Investors are also gradually seeking opportunities in broader credit markets across EM, DM and Japan/Australia, as well as local currency bonds and other asset classes such as convertible bonds.
In line with our preference for EM HY over EM Investment Grade (IG), we continue to favour HY in Asia, However, after the massive spread compression in 1H24, we see limited room for further material spread tightening but expect all-in yields to continue to support returns in 2H24, albeit largely from carry.
Regional review
In China, policy easing measures should benefit HY corporates as they continue to deleverage. As for China property, we see the shift in focus to destocking as a step in the right direction. However, effective execution and the transmission of such policy actions to actual sales improvement/stabilisation need to be closely monitored for any meaningful impact to liquidity and cash flows to developers. We await more clarity on additional forceful policy actions to accelerate the inventory digestion cycle and support home price stability and sustainable sales recovery.
A lack of prompt and effective follow through measures will likely disappoint the market again and lead to the unwinding of the recent market rally. Conversely, bolder policy measures to stem the downward spiral in the property market could uplift market sentiment.
We continue to like India HY and see the renewable energy sector as beneficiaries in the structural shift towards green energy and greater demand for power on the country’s high economic growth. Credit fundamentals of most issuers in the industry are underpinned by cash flow visibility and supportive government policies. While we acknowledge some challenges, such as highly capital intensive and elevated leverage, these are mitigated by good access to liquidity and strong shareholders.
For Indonesia, the country’s USD HY bonds outstanding in the JACI has shrunk significantly. The domestic loan market remains very supportive and provides HY corporates with alternative cheaper funding sources. In fact, LMEs such as bond tenders and refinancing through onshore bank loans have been one of the key factors behind the reduction. YTD 2024, ~USD1.4b of Indonesia HY corporate bonds have been repaid/refinanced, leaving fewer investible bonds in this space. With more upcoming bond maturities, we expect the space to continue to shrink until new issuance picks up after US rate cuts.
On the back of the shrinking Asia HY universe, investors can also look to opportunities in the broader credit markets across EM, DM and Japan/Australia.
Key downside risks include geopolitical risks, resurgence of US-China tensions, imposition of additional significant tariffs and/or new investment restrictions by the US on China, increased bond supply, significant global and domestic economic slowdown, elevated inflation resulting in higher for longer rates environment hurting credit fundamentals, credit rating downgrades, default risks, corporate governance concerns, policy disappointments from China, currency depreciation impacting coupon servicing, wider credit spreads, slower than expected pace of rate cuts, weak market sentiment etc.
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