Market Insights

Chart of the Month

In this monthly series, we highlight an interesting chart in the Asian fixed income space, explain the underlying trend and share our insights on why we think it is important.

China property sector being underrated?

chart of the month-august

Source: S&P Global, 30 April 2021. Due to rounding, the total may not be equal to 100%.

A lot of the recent volatility in Asian high yield has been from the Chinese property sector, especially the single B space, due to continuing tight financial conditions. The concerns fed through to sentiments and we saw Asian single B spreads trading significantly over US single B credits; implying a China property sector default rate of over 15%1.

We believe this default situation is unlikely given improving credit profiles and the strategic importance of the property sector to China’s economy. In addition, we are seeing an increase in the number of developers complying to the three red lines (a measure of financial health; the more lines passed, the better the fundamentals).

We believe that cheap valuations in the Chinese property sector are not in line with its improving fundamentals. As active managers, we think its oversold B-rated segment is a good place to capture opportunities.

1Source: ICE BAML Indices, 30 Jul 2021

 


 

Should investors fear the credit events in China

chart of the month-may

For illustrative purpose only and there is no guarantee that the forecast will be realized. Source: JPMorgan Chase (Asia, US, Emerging Markets), BlackRock, April 2021 data and forecasts. Any opinions and/or forecasts represent comments on the market environment at a specific time. Estimates are not intended as predictions, guarantee of future events or future results. Index performance is for illustrative purpose only. Investors cannot directly invest into an index.

Recent credit events in Chinese state-owned enterprises (SOEs)  and property sector have triggered investors to re-evaluate credit risks in their onshore bond exposures. We remain positive on China’s high yield property sector but expect policy tightening to weigh on near-term sentiment. As the sector enters its peak sales season, the government has introduced regulations to cool down the sector to ensure leverage is being controlled. This is equity negative but bond positive, and can be seen as a good development for the sectors’ credit profile over the long run.

We see a potential tick up in Chinese credit defaults this year, but not enough to pose systemic risks. We continue to expect a tighter credit environment onshore as the government is seeking to de-lever the economy and this means the strategic important SOEs will continue to outperform the industrial SOEs.


 

Asian credit and Asian high yield can better withstand rise in interest rates

Asian credit and Asian high yield

Source: BlackRock, 26 Feb 2021. Past performance is not a guide to future performance. Asian Credit: PM Asian Credit Index; Global Aggregate: BBG Barclay Global Agg Corporate Index; Asian High Yield: JPM Asian Credit non-IG Index; Global High Yield: ICE BAML Global HY Constrained Index (100% USD Hedged). Index performance is for illustrative purpose only. Investors cannot directly invest into an index.

Bond performance consists of price returns and interest income. Rising interest rates cause bond prices to fall, negatively impacting price returns. Yield / duration ratio measures the breakeven point at which falling bond prices will overwhelm the interest income, thereby resulting in a capital loss. All else being equal, the higher the ratio, the more your yield can withstand a rise in rates.

Interest rates, especially the 10-year treasury yield, have slowly begun to normalise from low levels. It would be prudent to invest in an asset class that is resilient to the ongoing rise in interest rates. Because of their higher yields and lower duration, Asian Credit and Asian High Yield have better yield / duration ratios than their global counterparts, allowing them to better withstand the impact of rising interest rates.


 

Asian high yield delivers higher yield at lower default rate

Asian high yield delivers higher yield

Source: Default rates from JP Morgan, 31 December 2020. Indices used for yield are ICE BAML Corporate indices, 29 January 2021. Index performance is for illustrative purpose only. Investors cannot directly invest into an index. There is no guarantee that any forecast will come to pass.

2020 saw a divergence in default rates between Asia and the US. US high yield (HY) default rate was double of Asian HY, mainly due to the impacts of the energy sector on the US HY market. Recoveries were also vastly different, with Asia HY at 40% versus US HY at 16%.1  

For 2021, US HY default rate is expected to be 4% while Asian HY default rate is expected to ease to around 2.4%. However, despite subdued expected default rates, Asian HY delivers a yield that is more than 2% higher than US HY.  This discrepancy highlights an opportunity in Asian HY as an asset class that can potentially offer high income supported by strong fundamentals.

1Source: JP Morgan, 31 December 2020.


Asian Credit to Benefit from Stronger Expected Growth in Asia in 2021

Asian Credit to Benefit from Stronger Expected Growth in Asia in 2021

Source: JP Morgan Global Outlook, September 2020. For illustrative purpose only. Subject to change. There is no guarantee that any forecast will come to pass.

Recent economic data has demonstrated that the Asian economic recovery has extended beyond North Asia to other parts of Asia. We believe that the efforts to contain the pandemic, coupled with an incoming vaccine, should buoy laggards in this recovery.

In India, for example, signs of recovery can be seen in economic indicators such as industrial production, purchasing managers’ indices and inflation. It should benefit greatly from the vaccine and the rebalancing of global supply chains.

This supportive macroeconomic backdrop, stable corporate fundamentals, attractive yields at a moderate duration means that Asian Credit is well-placed to attract global investor flows.

 


Asia’s economies return to
pre-Covid level

Asia’s economies return to pre-Covid level

Source: Haver Analytics, 31 October 2020. The headline numbers are represented by a diffusion index, which is a cross-sectional method to analyze common tendencies among multiple time-series. It aggregates multiple indicators by examining whether they are trending upward or downward. For illustrative purpose only. The information shown is not exhaustive and should not be construed as investment advice and is not intended as an endorsement of any specific investment.

North Asia has been the main driver of regional recovery from the coronavirus pandemic. In 2021, we expect this to extend across the rest of Asia.

Signs of this broad-based recovery at a regional level can already be seen across the manufacturing and services segments. We believe that the efforts to contain the pandemic, coupled with an incoming vaccine in the next few months, should continue to buoy laggards in the Asian macroeconomic upturn.

The search for income outside of core developed markets by investors might further intensify. Asian credit looks attractive because of its higher yields, when compared to developed market counterparts1,  as well as its superior macroeconomic fundamentals.

1Source: Bloomberg Barclays indices, 31 October 2020.

 


Navigate FED actions with Asian credit

Asian fixed income’s low sensitivity to US Treasuries reduces portfolio volatility and boost risk-adjusted returns

Source: Bloomberg, as of end Aug 2020, based on the weekly returns over past 3 years. US Treasury refers to iBoxx US Treasury 7-10Yr total return Index; Onshore China Bond refers to Bloomberg Barclays China Aggregate Index (USD Hedged); Asian Credit refers to JP Morgan Asian Credit Index; Asian High Yield refers to ICE BAML Asian Dollar HY Corporate Constrained Index; US Investment Grade refers to Bloomberg Barclays US Corporate Total Return Index; Global Investment Grade refers to Bloomberg Barclays Global-Aggregate Total Return Index Value USD hedged. Index performance is for illustrative purpose only. Investors cannot directly invest into an index. Past performance is no guarantee of future results. Not a recommendation to buy or sell. Subject to change.

Although we see little likelihood of sharp movements in US Treasury yields in either direction, comments and actions from the US Federal Reserve will continue to add volatility in yields.

Building an allocation to Asian fixed income can help provide resilience in your portfolio, reduce volatility and boost risk-adjusted returns. Asian credit, high yield and Chinese bonds all display low sensitivity to US Treasuries.

 


Why has Asian fixed income been relatively resilient this year?

Why has Asian fixed income been relatively resilient this year?

Source: BlackRock, Aug 2020. For illustrative purposes. Asian Credit Represented by J.P. Morgan JACI composite Total Return; Global Aggregate represented by Bloomberg Barclays Global-Aggregate Total Return Index Value Unhedged USD; Asian High Yield Corporates represented by ICE BAML Asian Dollar HY Corporate Constrained Index; US High Yield Corporates represented by ICE BAML US HY Index. Index performance is for illustrative purpose only. Maximum drawdown YTD as of 07/31/2020; Yield represented by yield to worst as of 8/11/2020. Investors cannot directly invest into an index. Past performance is no guarantee of future results. Not a recommendation to buy or sell. Subject to change.

We believe Asian credit and Asian high yield have low exposures to the cyclical sectors that have displayed vulnerability in this year’s volatile market environment. This, along with the stable investor base and strong fundamentals, has allowed both asset classes to provide investors with an attractive yield while experiencing relatively more muted drawdowns than their global peers.

These cyclical sectors will continue to be affected as global economies continue to deal with the impact of the Covid-19 pandemic. At times like these, investors benefit not only from higher income levels but also the buffering ability of these yields against market turbulence.

 


Reasons why we don’t expect a sharp increase in China onshore default 

Despite the extreme pressure from the Covid-19 pandemic, the onshore default amounts remain low (relative to the RMB 46 trillion credit market1) and is tracking previous year. We believe the risk of a sharp increase in default is very low due to :

  • The deleveraging cycle that started in 2017 led to defaults of weaker credits onshore in prior years. As a result, the size of potential default universe becomes smaller.
  • The exposure of China bond to Covid-19 affected sectors such as energy and hospitality is significantly low compared to global counterparts.
  • We have seen targeted policies to support SMEs funding channels and to improve credit transmission in the system.

Credit differentiation offers active managers an opportunity to enhance returns by seeking a deeper understanding of company-specific fundamentals and allocating to companies with strategic and social importance to the state.

Reasons why we don’t expect a sharp increase in China onshore default 

 

Source: Wind, end June 2020. For illustrative purposes only.

1Source: Wind, end June 2020

 


Divergent performance between onshore and offshore Chinese bonds

Chart of the Month - June

Source: BlackRock, as of June 2020. Onshore China bonds refers to ChinaBond Credit Bond Index; Offshore Chinese credit refers to JACI China Index. The drawdown/recovery period for 2018 trade tension is based on the offshore Chinese credit performance from the peak to trough (3/31/2018 to 7/12/2018) and trough to recovery (7/12/2018-8/28/2018), respectively. The drawdown/recovery period for 2020 Covid-19 sell-off is based on the offshore Chinese credit performance from the peak to trough (3/9/2020 to 3/23/2020) and trough to recovery (3/23/2020-5/31/2020), respectively. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.

US China trade tension is likely to stay elevated and will benefit onshore China bond; during the 2018 trade tension, the onshore market delivered positive returns with ample liquidity. Onshore China bond is a good potential hedge against trade tensions as China still has room to implement easing policies. Post sell-off, offshore Chinese credit tends to rebound significantly as cheap valuations can attract potential inflows from investors searching for yield. Another example is during Covid-19 where we saw divergent performance between onshore and offshore markets.

During market uncertainty, having the flexibility to invest in both onshore and offshore Chinese bonds is paramount to capture potential upside and minimize downside risk.


Performance of China onshore credit vs US bonds

Chart of the Month - May

Source: BlackRock, Bloomberg, end April 2020. The figures shown relate to past performance. Past performance is not a reliable indicator of current or future.  China onshore credit: China Bond Credit Index; China USD credit: J.P. Morgan China Credit Index; US IG Bonds: Bloomberg Barclays US Corporate Index; US HY Bonds: Bloomberg Barclays US High Yield Corporate Index. Index performance returns do not reflect any management fees, transaction costs or expenses. Indices are unmanaged and one cannot invest directly in an index. Index performance is for illustrative purpose only.

Onshore Chinese Credit is now the second largest credit market in the world, with a deep set opportunity for high yielding assets, comparable to the US1. The market has shown resilience in recent risk-off environments, notable 2018 trade tensions and the Q1 coronavirus outbreak. Low foreign ownership onshore2 means that the onshore capital markets are insulated from noise in the offshore markets. The liquidity in the onshore bond market remained ample and was one of the few asset classes that generated positive returns in March3.

Having onshore credit exposure gives portfolios access to another pool of liquidity if a liquidity crunch is observed again and can deliver resilience to portfolios during offshore market downturns.

1 Source: BIS, World Bank, end Jun 2019.
2 Source: JP Morgan, Wind, end Dec 2019.
3 Source: BlackRock, end March 2020