What’s helping Asian high yield bonds?

“It’s central banks,” says Ross Dilkes, Portfolio Manager for the UBS (Lux) Bond SICAV - Asian High Yield (USD).

09 Oct 2019

Central banks action will help Asian high yield bonds

After nine rate hikes since 2015, the Federal Reserve (Fed) has started easing interest rates in early August 2019.

Ross explains that this has given central banks in Asia the flexibility to lower their policy rates. In fact, Asian central banks have already preempted the Fed’s move and have cut rates in 2019.

Malaysia, Philippines, India, Indonesia and South Korea have eased rates since May. Ross expects central banks to bring rates lower because “inaction is more worrying than the longer-term consequences for central banks. If central banks don’t act, their economies could slow too much. This is a larger and more immediate threat than worrying about asset price inflation or other negative impacts.”

In general, lower interest rates will help boost the economy as it becomes easier for businesses and consumers to get funding. A more dovish Fed also boosts global liquidity and this can help demand for higher income generating risk assets such as Asian high yield bonds.

Numerous rate cuts across Asia

Source: Bloomberg, UBS Asset Management, 30 September 2019

But how are Asian high yield issuers doing?

“Most companies, at least those that we invest in, are well-placed to service their debt. As a fundamental investor, my team and I focus on cash generation ability. There are attractive businesses in the region with sound cash levels and we have seen improvements over the last 5 years”, says Ross

Ross explains that interest expense coverage is also important because that measures a company’s ability to service its interest payments. Interest expense coverage ratios are strong with cash earnings (EBITDA) for Asian companies at about 3 times that for interest payments.

EBITDA refers to earnings before interest, depreciation and amortization.

Good interest coverage ratio

Source: JP Morgan. For illustration purposes only. Data available as of July 2019.

Beware of yield traps

But not all companies are equally well-equipped for future uncertainty warned Ross.

Some lower quality rated companies may offer optically attractive yields and investing in such high yielding issues can boost the income for portfolios but this comes at a significant risk.

Ross explained that as the economy slows, investors will differentiate between the strong and weak companies. He pointed out that in the first half of 2018 when investor sentiment was still relatively stable, most of the weaker high yield securities were trading not too far away from their higher rated peers. However, as the trade war intensified and risks in financial markets grew, those with weaker balance sheets tend to be sold down more drastically.

In our current environment where many risks stand in the way, “it’s best to avoid these yield traps.”

“And there’s no running away from doing research on companies. Our Asian credit analysts focus on industry trends, company financials and are often on the ground speaking with management and supply chains to corroborate the facts. With this 360 view, we can then pick and choose names with the best risk and yield payoff.”

Allocate nimbly to navigate market volatility

Financial markets have been challenging since May 2018 and investors need to be pro-active in managing risks, advised Ross.

He has been dynamically hedging the portfolio for negative events like a breakdown of the US-China trade war negotiation or a significant slow-down in China.

The key is to be nimble in allocating capital within the Fund and “position for where we see value.” While this is a credit fund, Ross is happy to move money away from corporate securities to other opportunities. “It’s one way to de-risk, to protect returns especially when markets are volatile,” says Ross.

He cited the example of how he trimmed allocation to credit as the trade war escalated in late March. In May, as valuations for high yield bonds became more compelling, he added these back to the Fund.

Ross has also taken short positions on Asian currencies against the Dollar or Yen. As the trade war between US and China showed no signs of abating, regional economies will likely slow and central banks in Asia will likely cut rates to boost growth.

The other way Ross has protected the portfolio is buying into US Treasuries. When markets are choppy, such safe assets have done well and our positions there have provided a downside buffer to the returns in the UBS Asian High Yield Fund.

Outlook

The ongoing trade war may have dimmed global growth prospects and Asia will be affected too. However, relatively speaking, Asia continues to stand out with stronger growth. “And in a world of $15 trillion* of negative yielding debt, Asian high yield bonds will be attractive for investors,” says Ross.

At the moment, the yield to maturity is about 7.5% for market.

Ross adds that many of the high yield securities in the region are not export-sensitive names and do not expect their earnings to be too badly impacted by global trade issues. However, headline risks are causing markets to be volatile and that’s where he reiterates the need to “be nimble to navigate the volatility” so that clients have a less choppy ride investing in Asian high yield.

*Source: Bloomberg. Negative yielding debt based on Bloomberg Barclays Global Aggregate Index MV USD. Yield to Maturity based on JP Morgan Asia Credit Index Non-Investment Grade, 30 September 2019.

Ross Dilkes

UBS Asian high yield

Ross Dilkes is a portfolio manager with the Pan Asia fixed income team and has strategy responsibility for selection of corporate issues in Pan Asian portfolios. Ross also contributes to the development of sector and industry allocation strategies across Pan Asia portfolios.

Ross joined UBS Asset Management in December 2005 as a credit analyst within the European Credit Research team based in London.

Ross transferred to the APAC Fixed Income team located in Hong Kong in 2009 where he was responsible for credit research coverage of APAC investment grade and high yield issuers.

Prior to joining UBS Asset Management, Ross worked for Debtwire in London as an analyst covering high yield, distressed debt, leveraged finance and restructuring situations.

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