We caught up with Ross Dilkes, portfolio manager for UBS Asset Management’s Asian high yield strategy to hear his thoughts on how he is investing in the asset class during the COVID-19 outbreak.
He brought up three pointers for Asian high yield investors to bear in mind:
Asian high yield outlook 1. Income in not everything; quality counts too
Many investors look to Asian high yield for its strong income potential. As rates in most of the developed world are dropping to zero (or close), the appeal of the asset class has become stronger.
While Asian credit with yields in the higher end of the spectrum may look tempting Ross cautions against blindly investing in them just for the sake of chasing the highest yields.
Income is not everything in high yield investing. Bond prices fluctuate and investors need look at total returns. This means taking holistic view of returns and accounting for adverse credit events, said Ross.
To get a gauge on this, Ross relies on the meticulous company research done by our credit analysts in the Asian fixed income team. Research helps to identify some of the higher yielding credits with weak fundamentals; this could be due to the poor industry outlook which they operate in or companies with weak balance sheets or strategic positioning.
While prices of these higher yielding credits may hold up well during non-crisis periods, they are likely to be rattled badly when there is market stress. "And very often, the high income received may not be enough to compensate for the loss if bond prices fall,” Ross added.
Our preference has been to hold better quality names within the Asian high yield space.
As we have seen in the COVID-19 outbreak, high yield names, regardless of their ratings, have sold off indiscriminately across the board. This was caused by investors who required liquidity and sold off higher quality assets first as there were no takers for those in the lower end of the rating spectrum (which have already been performing badly).
As the COVID-19 outbreak eventually stabilizes, the better rated high yield credits will be the first to recover as their operations are more robust, their balance sheets more resilient and they have more diverse financing channels available. As for the lower rated ones, we expect their price recovery at a much later point when the higher rated assets have fully priced in the potential return expectations.
In Asian high yield bonds, we had estimated 2020 default to be around 3% at the start of the year. Given the different circumstances, we have now revised this to 5-6%. At this level, investors in Asian high yield are still well compensated for those risks.
Now’s the time for Asian high yield bonds
"We expect to see a normalization in yields over the next 1 -2 years and that will create a very compelling opportunity … from a return perspective"
Asian high yield bonds
Asian high yield outlook 2. Stay active, be nimble, think dynamically
Ross spoke about how the focus on total return drives the way he and the team manage and position the UBS Asian high yield strategy. “We look at total returns and not just headline yield because we want to limit downside risks for investors. To be successful, we need to be nimble in allocating capital and position in where we see value,” said Ross.
Cash as liquidity buffer and ‘risk lever’
While the COVID-19 outbreak was still a China-centric issue at the start of this year, Ross started building up cash in anticipation as he thought that markets were not pricing in the risk of a possible slow-down there. As the outbreak spread globally, this cautious move was useful as “we were not forced to sell any securities for cash”. This has helped the strategy to successfully steer through some very volatile days.
In addition to serving as a liquidity buffer, the increased cash in the UBS Asian high yield portfolio also acts as a “risk lever”.
Holding cash gives us the ammunition to buy back into relatively cheaper credits as we spot opportunities.
Ross also manages duration actively. At the start of 2020, the portfolio was structurally overweight in duration as the team have been expecting further rate cuts. With the Federal Reserve (FED) cutting their policy rate now close to zero, the duration position was reduced to neutral (vs the benchmark).
Another example where Ross has put capital to work swiftly is in Asia currencies. With poor sentiment and falling tourist arrivals, Asian currencies have generally not fared well. So he has been proactively looking to short some Asian currencies against the US Dollar and Japanese Yen. This has been a complementary driver of returns, supporting the implementation of our strategic views.
Currency positions are a small part of the overall portfolio and are only used tactically when opportunities arise.
Asian high yield outlook
3. China is important but don’t forget India and Indonesia
China is a major issuer in the Asian high yield universe and has a market share of more than 50%. And China real estate companies have been tapping the offshore market to raise funds for its projects. At the moment, China real estate is about 38% of the Asian high yield market.
Chinese property high yield issuers can be mis-understood by investors. And that’s again where the due-diligence of our analysts come in.
Ross explained that the structural dynamics in China makes the investment case for Chinese high yield real estate companies compelling. “A lot of the what’s driving demand is urbanization and the growing middle class. These trends will continue to stay as China progresses.”
With the COVID-19 outbreak now stabilized in China, the on the ground channel checks have shown that activities are picking up in property sales offices and construction sites.
China, India and Indonesia are major high yield markets in Asia
However, not all China high yield real estate issuers are worth investing in, Ross cautioned. The UBS Asian high yield strategy is invested in large, leading property developers. These companies have more diverse funding options and that is useful today where liquidity is scare. Over the years, they have also accumulated the experience in dealing with severe market cycles eg in 2011 and 2014.
And there are risks to our outlook, especially if the government decides to control house prices. However, housing is a key store of wealth for Chinese and very important to China’s economy. That’s why Ross and team believe the government will maintain a fine balance between controlling speculation and promoting growth.
But the UBS-AM team looks actively outside of China too. India and Indonesia are two other important markets in the Asian high yield space. The India high yield market has been stressed and this sort of environment is really useful in differentiating our investment process. There are many businesses there with scale and strong management. We find opportunities that fit our investment criteria and that is why we built up positions in selected sectors in India like alternative energy.
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