Asia high yield: market update

Asia’s high yield market has been under the investment spotlight recently, so we sat down with Ross Dilkes, Asia Credit Portfolio Manager, and asked him some key questions.

29 okt 2020

Asia high yield: key takeaways

  • Further spread compression is expected in Asia high yield in the coming months;
  • Coupled with attractive rates of carry, spread compression means investors may see decent returns;
  • Defaults may rise in the coming months, but that’s where strategy managers with an active approach can navigate volatility;

1. Do you expect Asia high yield spreads to continue to tighten in the next 12 months?

In short, yes, we do expect to see further compression in spreads and that should support investors’ overall returns. 

Since March 2020 until now we have seen a significant compression on the back of a strong market rally underpinned by central bank interventions and a strong fiscal response. At current levels, spreads are still elevated compared to historical levels and going into 2021 we see room for further spread compression.

In addition to the spread compression over the coming months, the Asia high yield market continues to offer an attractive rate of carry. Put together, we believe these two factors offer an attractive proposition to investors.

Asian USD Credit Market: Spreads

2. Defaults in the high yield space are creeping up, what are you doing to avoid them?

Firstly, keeping our focus on downside risk management.

This is a key part of our approach, and one which worked well for us throughout 2018 and 2019. During that time, there was an underappreciated amount of stress in Asia, and our research-driven, bottom-up approach helped us navigate the market trends and in particular credit selection then.

Secondly, acknowledging some of the industry trends that are now accelerating.
We don’t have much exposure to commodities and consumer cyclicals, which we feel are under continued pressure right now. Where we have exposure to these sectors, we continue to hold them for a strong bottom-up conviction at the right valuations.

Finally, on the issue of liquidity, we are continuously assessing carefully about how we manage our cash position and how we manage sectors where liquidity may dry up quickly in a stressed environment. 

Default rates across high yield markets

3. How did you navigate through the COVID-19-induced market volatility seen in 1Q20?

When we started to see challenges emerge locally in Asia, we derisked quickly and significantly to raise our liquidity buffer in late-January and early February.
In high-yield markets when liquidity dries up, a sufficient cash buffer in the portfolio is key – which is why we had to be early and effective in raising liquidity to protect investors.

Because of the early steps we took, we did very little selling in March when liquidity conditions tightened dramatically, and in fact were buying in certain areas, profiting from cheaper valuations.

In addition to taking decisions around credit, we also ran long-duration strategies to capitalize on the compression in sovereign yields as the US FED cut rates to zero.

In terms of our FX management, we positioned short in Asia FX versus the USD as protection in the broader risk-off move.

Blending all three alpha levers holistically – credit, duration, and FX management – helped us get through what was an extremely challenging market environment. 

4. What makes your approach to Asia high yield different to competitors?

The typical Asian credit strategy aims to run credit in a long-biased way, at all times. That’s fine if you have very wide spreads, high yields and a high conviction around the outlook.

However, the last few years have seen higher volatility and more dispersion in markets and – at times – challenging credit conditions. Currently, it is unlikely that anyone has absolute confidence in the outlook for COVID-19 and other key macroeconomic factors.

Where we are different is that we take an active approach to investing in the Asia high yield space – using the credit, duration, and forex levers discussed above – which adapts quickly and aspires to help get investors through all different types of environments.

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