The downward trend in China’s GDP growth, exacerbated by the trade dispute with the US, is a critical factor that is likely to impact Asia bonds, warned Arthur Lau, head of Asia ex-Japan fixed income at Pinebridge Investments. “If China’s growth becomes slower than what the market expects, there would be quite significant negative implications to the asset class,” he said.
Nonetheless, Sheldon Chan, associate portfolio manager at T Rowe Price, believes there is a case for Asian credit.
Speaking at a media roundtable in Hong Kong last week, Chan said he believes Asian credit offers “an attractive risk-adjusted return profile compared with other fixed income categories” (see chart below).
The asset class has expanded at a compound annual growth rate of 15% during the past decade, while investment from the region is also increasing, accounting for 76% of primary Asian bond allocations in 2018 compared with 54% in 2010, according to JP Morgan data.
Chan believes both trends indicate that the market is becoming more liquid and a core exposure for a knowledgeable investor base.
He added that Asian corporate borrowers are improving their leverage profiles and as result, default rates are low. Asian high yield issuers “have consistently lower default rates dating back to 2002, and their lower leverage has not come at the expense of profitability, as the region [on average] is forecast to deliver double-digit earnings growth in 2020”, according to Chan.
The average credit rating in the asset class is BBB+, which Chan said makes it “a high quality asset class”.
Finally, “active management adds value, particularly in less efficient markets”, said Chan. Asian credits pay a yield premium over equivalent US corporate bonds, except for those rated BBB where spreads (over US Treasury yields) are about the same.
“With a yield profile of about 3.9%, the asset class also offers income opportunities at a time when nearly a quarter of global bonds have a negative nominal yield,” said Chan.
The $27.4m T. Rowe Price Asia Credit Bond Fund, has returned 10.3% since it was launched 18-months ago, compared with 7.46% return for its US fixed income sector average, according to FE Analytics data. However, its returns have been less stable, experiencing 2.26% annualised volatility versus 1.79% for the category average.
The fund, which is managed by Chan and his colleague Samy Muaddi, is overweight sub-investment grade bonds, with a concentration in BB names, and underweight investment grade issues, compared with its JP Morgan Asia Credit Index (Jaci) diversified benchmark, according to the most recent factsheet.
Among the fund’s largest individual holdings are sovereign issues from Indonesia (BBB), Pakistan (B-), the Philippines (BBB+) and Sri Lanka (B).
However, the credit rating disparity with the index is largely derived from a substantial exposure to China, which includes a preponderance of BB-rated property companies, and a reduced exposure to Singaporean and South Korean high quality – but low yielding – bonds.
So far in 2019, the fund has delivered 10.4%, compared with 9.1% by the Jaci, largely on the back of price appreciation, according to Chan.
However, Chan said one risk is linked to continuing demand from Asian investors.
As he pointed out, the Asia credit market grew more than four-fold over the past decade to $980bn in outstanding debt in the second quarter, as Asian companies increasingly used the capital to fund growth plans. The region has accounted for more than 50% of emerging market bond issuance each year dating back to 2014, according to JP Morgan data.
“The supply programme remains quite heavy as companies need to refinance maturing debt, and the low interest environment is attractive for other companies to lock in long-term borrowing.”
However, new issue placement is increasingly dependent on Asia-based investors, so if their appetite dampens, then some borrowers might struggle to find buyers for their bonds.
An overhang of supply might lead to weakness in secondary market prices, and the performance of dedicated Asia credit funds would suffer.
10-year risk and return profiles of Asia credits and other fixed income categories
Source: T Rowe Price
T Rowe Price Asia Credit Bond Fund versus US fixed income sector average