The article first appeared in The Edge Singapore.
China’s steady path to recovery will help Asian high yield bonds
Notably, China, the first country to implement a lockdown was also the first country to resume economic activity and we now see strong signs of a gradual recovery.
On the back of that, Asian high yield bonds are poised to rebound as well.
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At the start of this year, Asian high yield bonds were one of the asset classes favoured by UBS Asset Management (UBS-AM) to outperform. Their valuations did not look overly stretched and fundamentals were firm. In fact, the US and China had just signed Phase One of a trade deal to end a costly trade war.
Nevertheless, the pandemic took the world by storm, sending financial markets into a tailspin. Asian high yield bonds were not immune to the market turmoil too. To curb the spread of Covid-19, many countries initiated strict lockdown measures that inevitably forced the temporary shutdown of many industries, bringing economic activity to a halt.
Now as the spread of Covid-19 appears to come under control across some countries in Asia, economies are gradually starting to reopen. Notably, China, the first country to implement a lockdown was also the first country to resume economic activity and we now see strong signs of a gradual recovery.
On the back of that, Asian high yield bonds are poised to rebound as well. Within the Asian High Yield universe, China makes up for a significant share of the market with around 47%.
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Additionally, Asian bond yields are currently close to levels last seen during the global financial crisis in 2008, implying that valuations are attractive. This presents a good entry opportunity for investors.
Ross Dilkes, who manages the UBS Asian high yield portfolio, reckons that China should be on a steady path to recovery. “We think China is in a better place now as it has successfully contained the spread of the virus. Compared to the rest of the world, we think Asia, particularly China, stands to recover the fastest,” he says.
Dilkes’ optimism is underpinned by several factors. For one, the normalisation of economic activity to about 80% is “pretty dramatic”, he says. “That gives a lot of comfort to the outlook — for the rest of the year and beyond,” he says.
Secondly, China still has ample ammunition to spur its economy — either through fiscal spending or monetary policy. This was the result of the country’s measured policy response in the last two years.
We haven’t seen a huge government push on fiscal spending — the type of announcements made in 2008. So, China has room to take action to support its economy.
Moreover, China’s banking and financial system has grown robust over the years. Companies now have access to various sources of liquidity for working capital purposes and to meet financial obligations. This is unlike other emerging markets (EM), such as Indonesia and India, where avenues to raise funds are more challenging. “China’s got the ability to support private companies and make sure [there is no] significant pick up in refinancing concerns, which is quite unique compared to the rest of the EM world,” says Dilkes.
Asian high yield outlook Opportunities in China real estate
So, where in China does Dilkes see opportunities? The property sector, particularly the residential segment, looks attractive, he says. Demand for housing has returned and this has pushed up prices, he points out. “As most of the players are deriving a significant portion of their revenue from the residential market, the fund stands to benefit,” he says.
The fund, however, is avoiding the commercial segment of the property market. Dilkes notes commercial properties are facing pressure on rental reversions considering the impact brought by the pandemic.
The fund is also avoiding the office segment. Dilkes says people are increasingly questioning the future of workplaces in the next five to 10 years, given that work from home arrangements could take root.
“There’s probably more longer term question marks, if not stress around the office space,” he says.
Asian high yield outlook
Bond defaults in Asian high yield have not picked up materially
Crucially, bond defaults in China and Asia overall have not picked up materially, according to Dilkes. He reiterates that China’s fundamentals remain “pretty sound”. “In stressed situations like this, it’s not just necessarily about the business model but about liquidity and financing,” he says.
Overall, Dilkes is confident that the UBS Asian high yield strategy could do well on the back of China’s recovery.
Despite the challenges that the world has faced in the last few months, when we look at Asian high yield bonds, the forward-looking trends look attractive. And now is an attractive entry point for investors as yields are at levels last seen only during the Global Financial Crisis.
UBS Asian high yield strategy
Tap the opportunity in Asian high yield bonds
1 Source: UBS Asset Management, as of 31 Jul 2020. Past payout yields and payments do not represent future payout yields and payment. Payout yield does not equal to total return and is not guaranteed. Equivalent yield is derived from simple arithmetic calculation where the dividend is divided by the NAV, and annualised thereafter. Please use this for reference only. This share class which pays distribution may distribute not only investment income, but also realised and unrealised capital gains or capital. Where capital is distributed, this will result in a corresponding reduction in the value of Shares, and a reduction in the potential for long-term capital growth.
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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