Asian high yield: Positive outlook with strong policy support

Ross Dilkes, Portfolio Manager for Asian High Yield strategy, answers ten key questions ranging from market outlook to strategy positioning.

25 Sep 2020
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Riding on the resilience and monetary support in Asia, Asian High Yield strategy has offered very attractive yield pick-up relative to global high yield markets. The Asian high yield sector has less exposure to commodity markets and consumer sectors, which will continue to face challenges as the world tries to recover from the COVID-19 demand shock.

Ross Dilkes, Portfolio Manager of UBS Asian High Yield Fund, reveals his preferred picks in Asia: China property market, China financials, Indian renewables, as well as Indian TMTs.  

We hold a positive outlook for Asia high yield for 2020 with the continued accommodative stance of central bank policies, sound credit fundamentals and a supportive technical backdrop.

The yield pick-up relative to global high yield markets continues to be very attractive, providing a firm technical backdrop.

However, volatility is likely to persist into 2020 with the uncertainty of the spread of the coronavirus, a potential re-emergence of the trade war with the US and the US election cycle coming up. 

Within the Asian High Yield strategy, we have not had any liquidity issues throughout the COVID-19 crisis and hence no adverse impact on performance from lack of liquidity.

The funding environment for private companies in China has become more challenging so we believe diligent credit research will be ever more critical to protecting returns and minimizing potential capital loss in today’s environment.

On the credit side, the coronavirus has had a negative financial impact for Chinese credit. It is worth highlighting that we have seen numerous recent policy statements indicating strong support for financial market stability throughout this challenging period.

That suggests limited rollover risk for onshore credit in the coming months and should allay fears of a spike in liquidity pressure and defaults onshore and we do not expect any negative sentiment to spillover to the offshore USD market.

Yield is important as an approximate guide, but purely relying on it can be equally dangerous.

With credit stresses picking up, a significant amount of the yield in an index or a portfolio may in reality be coming from stressed credit with minimal chance of par recovery. Investors therefore need to be careful about basing return assumptions off yields alone.

Active managers have a big opportunity in times of high volatility. Dynamic risk positioning will be a more effective return driver than carry in fixed income over the next 2 years, which has also been evident through the last year or two as well.

Valuations in the Asian High Yield space look attractive as investors get a substantial yield pick-up with lower duration.

Secondly, we are expecting lower default rates in Asian high yield during the next 18 months compared with US and European markets.

Finally, the Asian high yield sector has less exposure to commodity markets and consumer sectors which will continue to face challenges as the world tries to recover from the Covid-19 demand shock.

That should help reduce volatility even if we see further disappointments in global growth as economies try to reopen gradually.

From a historical perspective, return statistics are in favour of Asian High Yield. Since the JACI index became available in 2005, Asian High Yield has outperformed both US High Yield and Europe High Yield with higher returns and lower volatilities and drawdowns.

One reason for this is that Asian High Yield is mostly held by Asian investors, many in held to maturity accounts. The US High Yield market is now dominated by ETFs and index funds which depending on retail flows could introduce volatility to the sector.

Yield/duration ratio for high yield (HY) and investment grade (IG) bonds

Our current default forecast for the Asian credit universe is 5-6%, compared with a 2-3% range in 2019. This still compares favourably to trends we see in high yield markets globally.

We do see diverging trends within the region. We expect Chinese defaults to be around 3% as the space benefits from better starting point fundamentals, targeted support by the government for the corporate sector and a Q2 growth recovery.

Other areas will likely face more refinancing pressure over the next 12 months but as an asset class it's also positive that it is not meaningfully exposed to commodity production and exports which we expect to remain under pressure near term.

Strategy highlight

The flexibility to complement credit returns with active interest rate and Asian FX strategy has produced a better total return and risk-adjusted outcome for clients.

- Ross Dilkes, Portfolio Manager of UBS Asian High Yield Fund

We believe our Asian High Yield strategy is more dynamic in portfolio positioning, utilising opportunities across the whole Asia region without structural bias.

The flexibility to complement credit returns with active interest rate and Asian FX strategy has produced a better total return and risk-adjusted outcome for clients.

We also maintain a dedicated focus on Asia which prevents style drift over time and finally we always ensure that our fund capacity appropriately reflects the underlying market liquidity.

Being too large to effectively navigate different liquidity environments can negatively impact fund performance over time.

Economic data in China indicates a strong recovery. August PMI numbers surprised to the upside, supporting the upbeat sentiment.

The private sector Caixin manufacturing PMI climbed to 53.1, up from 52.8 in the prior month. Profit growth of China’s major industrial firms continued to accelerate with +19.6% yoy as of July.

Monthly profits saw growth for the third consecutive month as the economy continued its recovery after the coronavirus-induced slump.

We continue to have a positive view on the Chinese property market. The sector is still underpinned by supportive demographics, a growing middle class, ongoing urbanisation and continued upgrades in housing.

Sales were temporarily affected after the outbreak but since there has been a steady recovery with the gradual re-opening in China since March.

Many leading developers have already returned to a substantial level of sales activities, and their construction work have also gradually resumed. Fundamentals remained strong and domestic financing channels remain readily accessible for established developers.

Whilst it's the dominant sector, however, Asian High Yield offers more than just access to the China property market. Growth in the universe has broadened the opportunity set and new sectors have emerged which have generated diversification benefits.

Additionally, as the China property market has evolved, issuers in the space have grown substantially meaning that now they are less sensitive to cyclical market adjustments, unlike in 2011 or 2014 when we saw the property market under pressure in China. This helps to mitigate the impact of a slower property market on the overall outlook for Asian High Yield.

There are a number of interesting new industry trends evident in the Asian high yield market. For example we have seen significant growth in renewable energy capacity in the emerging world in recent years.

As the sector grows rapidly it requires capital and we have seen issuers access high yield markets to fund expansion.

We think these types of investments are getting more and more focus from investors as sustainability becomes an increasingly core consideration for portfolios in the future.

In view of the gradual recovery from the economic lockdown and market turmoil through the COVID-19 pandemic, we retain flexibility within the strategy and adjust our exposure tactically as we expect market volatility to remain elevated.

In the first part of 2020 in anticipation of a more difficult and volatile market environment, we have proactively positioned the fund more defensively on credits with an overweight in duration to benefit from the yield compression in sovereigns where central bank policy action is more likely.

In terms more recent credit positioning, we like the China property space (strong sales pipeline, strong support, favorable broad trends), China financials (we like large banks with government ownership), Indian renewables (contracted stable revenues, solid shareholders, ESG story) as well as Indian TMTs.

In terms of key areas of risks, we continue to be cautious of commodities which remain under pressure as global demand is still subdued. We also are cautious on high yield sovereigns given the economic disruption adversely affected government revenues, increased expenses and debt to GDP has gone up.

Our cash holdings are maintained at elevated high single digit levels and we are looking at opportunities to invest as we see further volatility ahead.


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