Over the past few weeks, we have seen a significant sell-off in Asian high yield bonds. The benchmark Markit HY Index has seen its average yield rise from <5% in mid-2017 to recently exceeding 7.5%, the highest level since the index was launched. Asian HY has also notably underperformed US markets with the yield premium of B-rated Asian bonds (vs US issuers) increasing over 100bps since the start of the year.
Enticed by the more compelling valuations, this has left many investors asking if this is a buying opportunity. However, before answering this question,, it is worth understanding what is causing the sell-off. In general, Asian credit profiles have remained stable as evidenced by the recent 2017 results season and so fundamentals do not appear to be the main driver. On the contrary, we believe three main technical causes are the blame for the weakness.
The first is a supply/demand imbalance. Fueled by the fastest economic growth rate in the world, Asian companies have a constant need for capital that has seen the Asian USD bond market quadruple in size since 2013. However, like all rapidly growing asset classes, such expansion has inevitably hit a period of demand fatigue. In 2018, we have seen a large increase in issuance from HY companies, particularly from China. Tighter onshore liquidity has led to increased issues in the offshore USD market. This has created a vicious cycle where excessive primary offerings have repriced secondary markets lower, which in turn has necessitated ever more generous yields from new issues. Inevitably, we believe, this will hit a level where yields become too expensive for corporates to accept and we expect a slowdown in primary activity to be a catalyst for market stabilization and recovery.
Compounding this has been strength in the USD, which has hurt sentiment on global emerging market (EM) bonds. Within the Asian HY space, this has particularly hurt balance-of-payments deficit countries such as Indonesia and India, which account for 25% of the Asian HY Index. However, it is worth noting the current account balances of Asia’s EM economies have significantly improved since the last major sell-off in 2013 and so USD impacts should be less onerous this time round.
Finally there are the concerns centered around the escalating trade dispute between the US and China. Given the unpredictability of global politics, we cannot exactly predict the outcome of the tensions. However, it is worth noting Asia’s HY market is dominated by domestically focused industries. A global economic slowdown resulting from a trade war would negatively impact all asset classes but Asia’s USD bond market should be more insulated than many other sectors.
There may be other factors in play contributing to the weakness, such as reductions in investor leverage, changes in asset allocation of major institutional investors or potential government policies impacting sovereign linked buyers. However, we are yet to see material redemptions from the asset class and our channel checks with brokers indicates that most the sell-off has been on light volumes. We believe the market should see stabilization once the primary supply/demand imbalances have been addressed. This leaves the market at an attractive level of valuation and, while we think investors may wish to wait for market to stabilize before entering, we think this entry point is getting close.
Marcus Weston is based at JK Capital Management Ltd., a La Française affiliate