![\"Target](\"/_assets/images/articles/charts/fiaai/2022/fixed-income-asset-allocation-insights_december-2021-a.gif\" "\\"Target")
\n
Head of Asia ex Japan Fixed Income Arthur Lau shares a veteran investor's perspective of the Asia high yield market. We discuss why the asset class can't be ignored, the importance of the Chinese property sector, opportunities for patient investors, the secret behind his team’s zero-default track record, and more.
\nHosted by Aurelia Sax, deputy head of client services, EMEA.
\nAurelia Sax: Welcome to the PineBridge Investment podcast. I’m Aurelia Sax, deputy head of client services, EMEA. Today, we’re taking a closer look at Asia high yield with Arthur Lau, Head of Asia ex Japan Fixed Income and Co-Head of Global Emerging Markets Fixed Income. Arthur has been investing in Asia credit for more than 30 years and has seen the exciting development of the region’s high yield market.
\nAsia high yield is a rising asset class in the emerging market universe, attracting international investors for its competitive yields and other attractive features. Compared to other high yield markets, Asia high yield is distinctive in terms of its composition and key drivers of returns.
\nThank you so much for coming on this podcast, Arthur.
\nArthur Lau: Thank you for having me on the podcast.
\nAurelia Sax: Let’s start with the “why.” Why should investors, particularly those outside Asia, invest in Asia high yield? Some are asking if the market is too volatile.
\nArthur Lau: We believe Asia high yield adds significant value to global portfolios. If you compare yields, Asia high yield offers highly competitive yields vs US high yield, with lower duration. Holding shorter duration bonds in today’s environment is important as we believe it helps mitigate interest rate risk, particularly as the Fed has signaled a winding down of bond buying activities amid rising inflation. With careful credit selection, one can find sweet spots across ratings, sectors, and markets. As you know, Asia bonds are still underrepresented in global benchmarks, therefore a standalone allocation to Asia high yield is a good way to gain these diversification benefits.
\nWe believe the Asia high yield volatility in 2021 was not seen since the global financial crisis in 2008/2009 and was due primarily to the Chinese property sector and, therefore, not expected to persist. There are signs of stabilization at the very least as policy begins to shift, albeit slowly. In addition, the current credit spread levels have assumed excessive default risk, which we do not think is justifiable based on fundamental and technical factors. That being said, we remain cautiously optimistic because we believe there are companies that could survive after this cycle which are unfairly punished by the market because of the current risk averse sentiment. With the expected default in the Chinese property sector lower in 2022, potential returns in Asia high yield are quite attractive compared to previous cycles. Elsewhere, Asia high yield is actually pretty stable. Therefore, we think investors should not ignore this asset class simply because of the situation in the property sector.
\nAurelia Sax: In your recent 2022 Asia fixed income outlook, you spoke about opportunities in Chinese property bonds. I hope you don’t mind me asking, why are you positive on this segment of the Asian high yield market when recent headlines seem to tell a negative picture?
\nArthur Lau: In terms of headlines, we have actually seen welcoming signs of policy fine tuning. Beijing’s rhetoric seems to have changed somewhat also, saying that the continued health of the property sector is important. While we don’t think this policy fine tuning is strong enough to revise the current weak investment sentiment in the sector, that does suggest further tightening in the sector may have relaxed. And of course, there is still no shortage of negative headlines. For instance, the physical property transactions in December continued to decline while the market still needs to work through the defaults that happened in 2021. Meanwhile, we also expect more defaults or distressed situations to come in 2022 in view of heavy debt maturing schedule in the coming few months. All these will remain an overhang at least in the first half of 2022. That being said, we do find current valuation very attractive as the market continues to assume significant default risk, which do not reflect the fundamentals based on our analysis. We do not mean we should be aggressive in adding risk in this sector as we are still cautious and defensive. However, we do see opportunities in selective property developers that do not have near term liquidity or refinancing risks. So, the key is credit selection as the market sold off names in this sector regardless of their credit fundamentals.
\nAurelia Sax: So what do you think some investors are missing when they look at the Chinese high yield bond segment?
\nArthur Lau: Besides thorough credit analysis, we think policy direction and focus are important considerations in investing in Chinese high yield bonds. While policy direction may drive the risk sentiment and increase volatility in near to medium term, careful credit selection should enable to pick winners and avoid losers despite the market volatility. This should actually offer decent returns to patient investors. Take the Chinese property sector as an example, we think as the market realizes the policy shift and selective developers continue to perform well fundamentally, opportunities actually begin to emerge.
\nAurelia Sax: Aside from select Chinese property names, where else do you see opportunities for well-compensated risk in the Asia high yield space?
\nArthur Lau: Besides Chinese property names, we continue to like selective commodities sectors for strategic holding while the renewable energy sector is a potential candidate for trading opportunities.
\nAurelia Sax: Some investors may be turned off by the default risk in Asia high yield. How would you address this concern?
\nArthur Lau: First of all, we don’t think the default risk in Asia high yield is about the whole asset class. The sharp increase in Asia high yield default last year was mainly due to the surge in default in Chinese property credits. With the few heavy index-weighted issuers defaulting, we think the most sizable default should have already been known and reflected. Nevertheless, we do expect more default to occur in the near term given the heavy debt maturing schedule in the sector in the coming few months. However, given a much smaller scale and index weighting [for these issuers], we except the default rate to actually decrease to mid-single digit this year. So, again, credit selection is the key to avoid those potential default. Outside Chinese property, we think Southeast Asia sovereigns may face a potential debt restructuring situation, i.e. default. So, it appears to us that thorough credit analysis could avoid most of the potential defaults.
\nAurelia Sax: How will the ongoing pandemic, a potential US rate hike, inflation, China’s slowdown, and geopolitical tensions affect the outlook for Asian high yield?
\nArthur Lau: Given that Asia high yield tends to have shorter duration profile and higher interest rate cushion, they should have less impact from a rising interest rate scenario. We think China’s slowdown could potentially be a bigger drag given that over 50% of Asia high yield are from China. Nevertheless, Chinese government has turned more accommodative in monetary support as suggested by the recent reserve requirement ratio cut. We think this risk in near term may be manageable. In terms of the pandemic, we continue to believe governments in the region are more prepared, so it should not derail the steady recovery or increase the economic risk. However, recovery in some sectors, such as gaming may be further delayed. I think one other risk investors may need to watch out is the policy risk in China. This is more unpredictable and could introduce significant selloff in a short period of time, as we have seen from the education, technology, and gaming sectors last year. So, I believe investors should make sure they have a more diversified portfolio this year.
\nAurelia Sax: What’s your strategy in mitigating these potential risks?
\nArthur Lau: Careful credit selection and thorough understanding and appreciation of policy direction would be critical in Asia high yield. In addition, we should also pay more attention to the ESG elements because these will offer important indicators how a credit or issuer could operate under changing environmental or regulatory regimes. Take Chinese issuers as an example, G or the governance factor would be an area that investors should put more emphasis on as Asia high yield consists of largely privately owned companies. As such, a strong G factor will offer less potential credit risk to investors.
\nAurelia Sax: And what are your expectations for new issuances this year?
\nArthur Lau: I think new issuance overall this year would be flat. But it really depends on the situation in Chinese property. I would expect it is hard for Chinese property issuers to come to market at least in the first half this year until we see more concrete evidence of improvement in both the physical property transactions and the funding situation for the sector.
\nAurelia Sax: ESG is now becoming a key criterion for many institutional investors. How does ESG figure in your investment process? How are issuers in Asia responding to the growing demand for ESG and sustainability?
\nArthur Lau: PineBridge is one of the asset managers that adopted and integrated the ESG process in our investment process at the very early stage. We incorporated ESG considerations as early as 2015. We have a very decent ESG track record of companies that we cover, which enable us to analyze the development and evolution of the ESG situation of companies over cycles. In addition, we also compare ESG scores among sector and region so that we would be able to understand and access whether a company’s ESG practice is above or below peers. This is important for us also to evaluate the valuation over cycles.
\nOverall, Asia issuers are aware of the need in this area, although some sectors or sovereigns have done a better job than others. In fact, we have seen a significant growth of green bonds in recent years and expect this trend to continue especially in view of China’s commitment to reach carbon neutrality by 2060. That said, we think some regulators have moved faster than others in terms of formulating policies, guidelines and etc. so that corporates could follow, while others are still pretty much a work in progress.
\nAurelia Sax: If you look at new developments or trends in Asia high yield, what are you most excited about?
\nArthur Lau: Despite the sharp market movement due to the Chinese property sector in 2021, we actually see a meaningful increase in interest in Asia high yield since late last year as valuation looks really interesting. For instance, we have received more inquires on how to invest in Asia high yield and in fact, we have received allocation from global asset allocators to invest in this space already.
\nAurelia Sax: Could you tell us a little more about your team. How does the team respond to the rapid changes in the region? And also what is the key to your zero-default track record for Asia ex Japan?
\nArthur Lau: There is no short cut to achieve a zero-default track record. It is done through thorough and dedicated credit analysis, plus good risk management and control. Our team members have been in this industry for many cycles, so they are experienced in weathering through ups and downs. In fact, some have covered the same sector for over 10 years. We also have regular discussion through various forums within the region and globally in order to make sure we understand the dynamics of each sector to size our risk budget and allocation. Our analysis is based on a forward-looking principle, which enables us to make proactive investment decisions.
\nAurelia Sax: Thank you so much Arthur for all these insights. To wrap it up, what would be your 3 takeaways for investing in Asia high yield in 2022?
\nArthur Lau: Number one, careful credit work, no short cut. Number two, be patient and manage the risk. Number three, partner with a manager that has strong on-the-ground presence.
\nAurelia Sax: Thank you, Arthur. Well said.
\nTo the audience, thank you for listening to this podcast. We hope you found it insightful and helpful. For more insights from our investment professionals around the world, please visit pinebridge.com.
\nENDS
Investing involves risk, including possible loss of principal. The information presented here-in is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"How to Find Winners in Asia High Yield","custom_s_image":"/_assets/images/articles/article-cover-images/2022/01_2022_howtofindwinnersinasiahy.jpg","custom_ss_authors":["80377"],"custom_ss_author_links":["/bio/lau-arthur-cfa"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"Head of Asia ex Japan Fixed Income Arthur Lau shares a veteran investor's perspective of the Asia high yield market. We discuss why the asset class can't be ignored, the importance of the Chinese property sector, opportunities for patient investors, the secret behind his team’s zero-default track record, and more.","custom_s_local_url":"/en/investor-types/default/insights/how-to-find-winners-in-asia-high-yield","score":1.0},{"id":"181575","custom_i_asset_id":181575,"custom_s_title":"Fixed Income Asset Allocation Insights: Security Selection Will Drive Alpha in 2022","custom_dt_date":"2022-01-07T00:00:00Z","custom_s_description":"Led by high yield bonds and emerging market debt, most fixed income asset classes generated positive excess returns in December and retraced most of the losses from November. These gains came despite increased macro risks, including a more hawkish stance from the Fed and other central banks, continued high inflation, the rapid spread of the omicron variant, and increased geopolitical uncertainty in Europe.
\nWhile monetary policy normalization is imminent as the Fed and other central banks move to fight near-term inflation risks, the timing of the shift between tapering and tightening, as well as the number and pace of eventual rate hikes, remain highly uncertain. The market expects two to three rate hikes over the course of 2022, though with the current risks to the economic outlook, we believe more moderate policy changes could be likely. In addition, while the spread of the omicron variant threatens additional shutdown measures and thereby dampens growth expectations, particularly in Europe, the variant may be milder than other strains and therefore present less of a risk to the long-term outlook. Also on the positive side are relatively strong fundamentals and a technical backdrop that is expected to stay supportive into the year as issuance moderates and demand remains robust.
\nAgainst this backdrop, our fixed income allocations remain unchanged. From a total return perspective, we continue to believe that emerging market (EM) debt offers the most attractive opportunities, despite ongoing struggles in the Chinese property sector. That said, we believe a more selective approach is prudent. We continue to buy on weakness as negative headlines could result in increased volatility, presenting attractive opportunities for quality names. Within developed markets, given very tight valuations across asset classes, we expect yield to drive total returns and security selection to serve as the primary source of alpha generation in 2022.
\n\nFor illustrative purposes only. We are not soliciting or recommending any action based on this material. There can be no assurance that the above allocations will be in any account at the time this information is presented. This material must be read in conjunction with the Disclosure Statement.
John Yovanovic, CFA, Head of High Yield Portfolio Management
\nFundamentals
Fundamentals are largely unchanged from last month, remaining solid but facing stiffer comparisons as we shift into a mid-cycle recovery. The default rate remains very low, at 0.83% (JP Morgan as of 30 November). We expect default rates to remain around 1% into 2022. Management teams continue to note rising labor and input costs, but companies generally are getting price increases to compensate, in some cases with incremental margin.
Valuations
Omicron-related volatility caused Bloomberg US Corporate High Yield Bond Index spreads to move out to 340 basis points (bps) at the end of November before rapidly retreating to the 300-310 range (Bloomberg as of 16 December). We continue to believe that fair value option-adjusted spreads (OAS) are in the 270-300 bps range due to positive fundamentals and our 1% default rate forecast. Our spread model continues to suggest annual returns of 4% to 5%.
Technicals
Primary issuance set a record of over $515 billion in 2021. Volatility led to four-week rolling outflows of $1.5 billion, reversing inflows of November and leading to year-to-date (YTD) outflows of $16.5 billion. Given our view of marginally higher interest rates and less accommodative central banks, we expect relatively neutral retail flows and lower but positive institutional inflows in 2022. (Technicals based on JP Morgan Securities data as of 10 December 2021.)
We maintain our allocation of 35%. We expect a flatter but positive trajectory to fundamentals this year, a continuation of very low default rates, and a very accommodative primary issuance market. We continue to favor floating-rate loans and investment grade (IG) collateralized loan obligation (CLO) debt, as we expect rates to be a headwind in 2022. We still favor keeping portfolio risk around a beta greater than or equal to 1.0, maintaining relatively higher current yield and portfolio option-adjusted duration at or below index levels.
\nDana Burns, Portfolio Manager, US Dollar Investment Grade Fixed Income
\nFundamentals
With net leverage now below pre-Covid levels and rising stars expected to well outpace fallen angels in 2022, fundamentals have improved. Nevertheless, we remain concerned about margin pressure in the industrial sector due to rising input costs. The reopening of economies continues to drive demand.
Valuations
Credit spreads look more attractive given recent spread widening. We still find all-in yields and select credits and sectors attractive.
Technicals
The technical backdrop for credit has improved recently with the return of foreign demand. Low broker-dealer inventories (negative in the five- to 10-year bucket) remain. Near-term concerns surrounding Fed policy may slow demand.
Roberto Coronado, Portfolio Manager, Non-US-Dollar Investment Grade Credit
\nFundamentals
Neutral. Companies in general continue to beat expectations, while net leverage is slightly below 2020 levels; balance sheets remain in good shape. We continue to monitor merger and acquisition (M&A) activity given the recent increase, but we are still comfortable with the credit metrics.
Valuations
Neutral. Credit spreads have recently widened but are still close to fair value at the index level. We expect volatility to increase somewhat in coming weeks, albeit from very low levels. We still believe that sector and security selection are central to outperformance.
Technicals
Positive. The technical picture has remained supportive thanks to continuous buying from European Central Bank (ECB) programs and positive inflows into the asset class since the summer.
We maintain our allocation of 20%. We anticipate security selection to drive alpha generation this year, as we expect growth to slow, volatility to increase as the Fed tightens monetary policy, and spreads to experience bouts of weakness. We also expect issuance to slow, viewing this as a positive technical factor against the backdrop of steady demand from foreign investors.
\nAnders Faergemann, Portfolio Manager, Emerging Markets Fixed Income
\nFundamentals
EM growth will remain above pre-recession averages, despite slowing from a booming 2021. Key regional differences will bring opportunities in either local or hard currency bonds. EM debt/GDP profiles continue to improve, and outside of noisy headlines, we highlight the theme of quality and domestically oriented growth in 2022 (i.e., not driven by external factors). Several recent rating upgrades emphasize this as well.
Valuations
EMBI Global Diversified Index spreads widened to +390 bps at the end of November, breaking the year’s narrow range – partly due to lower US Treasury yields. The recent pullback is not complete, with the overall index at 370 bps, above the 340-360 bp annual range. IG remains rangebound at +149 bps, with HY at +650 bps (versus 611 last month). Some favorable revisions to IG fair value spreads have created opportunities despite the sideways spread moves. (Valuations based on JP Morgan and Bloomberg data as of 24 December 2021.)
Technicals
EM bond outflows at the end of November were quickly reversed in the first half of December; inflows remained positive for the year. Gross issuance should decline significantly in 2022 from 2021. Net issuance likely will be modest and centered around IG. January could be a lumpy issuance month.
Steven Cook, Co-Head of Emerging Markets Fixed Income
\nFundamentals
From JP Morgan’s tracking of 250 companies that have reported third-quarter results, revenues increased 21% YTD, EBITDA was up 32%, capex was up 9%, gross debt was up 2%, and net debt was down 2%. Gross leverage declined to 2.7x from 3.6x at year-end 2020, and net leverage fell to 1.5x from 3.1x. Last-12-month net leverage for IG debt stands at 1.2x (versus 1.6x at year-end 2020) and HY at 2.3x (versus 3.3x). Expectations are for a slight improvement in the fourth quarter and similar leverage levels next year. (Fundamentals based on JP Morgan data as of 13 December 2021.)
Valuations
The CEMBI BD spread-to-worst widened 16 bps on the month to 280 bps, with HY (wider by 24 bps) underperforming IG (wider by 7 bps). Through mid-month, HY retraced half of the widening seen in November, with most countries tightening except Turkey and China, driven by defaults in the property sector. We retain our bullish scores given that the market is currently mispricing the default risk on our coverage in Asia and because sovereign-driven moves elsewhere are creating value opportunities given the strong corporate fundamentals and outlook. (Valuations data from JP Morgan as of 15 December 2021.)
Technicals
YTD issuance has reached $529 billion gross and $70 billion net. Gross issuance in 2022 is expected to be similar, but net issuance is expected to be virtually flat at $3 billion, compared to net issuance of $60 billion-$90 billion annually over the last three years. The only region expected to have positive net issuance is the Middle East, at $34 billion. We maintain our scores given muted supply expectations, fund flows that have been relatively unaffected, and continuing new allocations to the asset class. (Technicals based on JP Morgan data as of 13 December 2021.)
We maintain our allocation of 25%. Despite fear-driven spread widening resulting from talk of renewed lockdowns, ongoing Russia/Ukraine noise, and defaults in the Chinese property sector, overall EM fundamentals remain strong. Spreads also remain attractive on a relative basis, yet the time of year may warrant some caution on technicals. As a result, we continue to buy selectively on dips.
\nAndrew Budres, Portfolio Manager, Securitized Products
\nFundamentals
Fundamentals are still challenging. Mortgage rates are going higher, but originators have no shortage of customers to refinance via cash-out products or lower-quality borrowers who were given short shrift during high production months.
Valuations
The mortgage-backed securities (MBS) market has brushed off the accelerated taper and continues to be more correlated to interest rate changes than Fed taper policies.
Technicals
MBS supply will be much lower in 2022 than in the record year of 2021, but a hot housing market will keep the mortgage churn going as home sales spur refinancings and new loans.
We maintain our allocation of 20%. The MBS market brushed off news of an accelerated Fed taper, so there is one less variable to worry about for the short term. Nominal interest rate direction, and its impact on refinancing and supply, is still the most important driver going forward. Against this backdrop, we are neutral on the asset class in the short to medium term. Longer term, the biggest risks we are monitoring are the normalization of the balance sheet and reduction of Fed holdings of MBS.
\nDmitri Savin, Portfolio Manager, Portfolio and Risk Strategist, Emerging Markets Fixed Income
\nFundamentals
Decoupling of monetary policy expectations between the Fed and the European Central Bank and the Bank of Japan remains the main driver of US dollar strength. Perceptions of policy shifts among the G10 central banks likely will dominate currency movements for several quarters. Yet financial markets may be running ahead of themselves, and the reality of three rate hikes in 2022 does not jibe with our base case, suggesting the US dollar could run out of steam unless other factors take over supporting the currency.
Valuations
Monetary policy divergence has been a key driver for the US dollar this year. We have maintained our euro/US dollar forecast of 1.1000-1.1500 and our US dollar/Japan yen forecast of 112.50- 117.50 for the next 12 months. We are slightly long the US dollar, underweight the euro, and neutral the Japan yen.
Technicals
According to JP Morgan and International Monetary Market data through 12 December 2021, net US dollar length is now about three-quarters of the 12-month average between the second half of 2018 and the first half of 2019. US dollar speculative positions are therefore elevated, but not necessarily stretched, as the current level versus five-year averages actually sits below one standard deviation.
We maintain our 0% non-dollar allocation. Arguably, the link between the US dollar and G10 yield spread has already been discounted by the market. As a result, we currently maintain a neutral stance.
\n![\"Fixed](\"/_assets/images/articles/charts/fiaai/2022/fixed-income-asset-allocation-insights_december-2021-b.gif\" "\\"Our")
Source: PineBridge Investments. For illustrative purposes only. Any opinions, projections, forecasts and forward-looking statements are based on certain assumptions (which may differ materially from actual events and conditions) and are valid only as of the date presented and are subject to change.
\n\nFixed Income Asset Allocation Insights is a monthly publication that brings together the cross-sector fixed income views of PineBridge Investments. Our global team of investment professionals convenes in a live forum to evaluate, debate, and establish top-down guidance for the fixed income universe. Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the global fixed income market.
\nInvesting involves risk, including possible loss of principal. The information presented here-in is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"Fixed Income Asset Allocation Insights: Security Selection Will Drive Alpha in 2022","custom_s_image":"/_assets/images/articles/article-cover-images/2022/01_fiaat-as-of-29-dec_jan-2022.jpg","custom_ss_authors":["80545"],"custom_ss_author_links":["/bio/vanden-assem-robert-cfa"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"Negative headlines and resulting volatility can present attractive opportunities in quality names, but a selective approach is critical.","custom_s_local_url":"/en/investor-types/default/insights/fixed-income-asset-allocation-insights-december-2021","score":1.0},{"id":"181261","custom_i_asset_id":181261,"custom_s_title":"Leveraged Finance Asset Allocation Insights: Will December’s Whiplash Make Way for Calmer Markets in 2022?","custom_dt_date":"2021-12-28T00:00:00Z","custom_s_description":"December’s market movements were head-spinning. At the start of the month, spreads on high yield bonds and bank loans rallied sharply as concerns about the severity of the omicron Covid variant receded. Strength continued, and by the middle of week two, spreads had retraced a majority of November’s widening with strong demand for high yield from retail investors and for collateralized loan obligations (CLOs) for bank loans. From there, spread-tightening slowed as November core Consumer Price Index (CPI) inflation reached a 30-year high, Fed Chair Jerome Powell and committee members struck a relatively hawkish tone on monetary tightening, and omicron cases jumped in the UK and New York City, along with a spike in delta-variant cases.
\nDespite this uncertainty, we expect the downside risks related to omicron to fade in early 2022 and for its economic impact to be limited and temporary. Beyond that, investors will look to balance the many current positives – strong corporate earnings, positive rating changes, and very low default rates – against the negatives of tighter monetary conditions, still-high inflation driven by supply chain constraints, and geopolitical tensions in Europe and Asia.
\nGiven this backdrop and the current valuations of various leveraged finance asset classes, we are finding attractive opportunities at the issuer level in high yield and leveraged loan markets. At the index level, we view aggregate valuations as fair given historically tight spreads but also a benign default backdrop and the potential for upward rating migrations. Within CLO debt, we view mezzanine tranches as inexpensive given the quality of underlying loans held in select CLO collateral pools. Globally, we view European high yield as relatively attractive vis-à-vis the US given current spread differentials and an attractive cross-currency basis for hedged US dollar-based investors. Finally, despite China’s property sector woes, we believe emerging market debt continues to offer attractive opportunities and that investors may benefit from a selective approach as quality names get caught up in negative headlines.
\nThe following sections reflect the investment team’s views on the relative attractiveness of the various segments of below-investment-grade corporate credit. Conviction scores are assigned on a scale from 1 to 5, with 1 being the highest conviction.
\nKevin Wolfson
Portfolio Manager,
US Leveraged Loans
CS 2.8 (unchanged)
\nFundamentals: With third-quarter reporting now complete, most loan issuers have exhibited solid year-over-year gains in their top and bottom lines. Growth should slow heading into 2022 given challenging comparable figures, pressured supply chains, and inflation concerns as input and labor costs rise. Corporate liquidity remains adequate, absent significant economic or structural catalysts driving greater reorganization activity, and we expect defaults to remain at historically low levels.
\nValuations: Although spreads have tightened over the last couple of weeks, they still are wide compared to where they stood before omicron concerns emerged. From 17 November to 14 December, the spread-to-maturity of the S&P/LSTA Leveraged Loan Index widened seven basis points (bps) and now stands at roughly L+405. During the same period, the weighted average bid of the market declined 23 bps to 98.41. CCC rated loans have widened 33 bps, while BBs and single-Bs have widened 5 bps and 8 bps, respectively. Spreads appear near fair value, remaining relatively attractive on a risk-adjusted basis versus other risk asset classes. (Valuations based on S&P/LCD data as of 14 December.)
\nTechnicals: Recent volatility associated with the omicron variant has begun to subside, and the market remains relatively in balance. On both the supply and demand side, new loan issuance and CLO formation began to slow heading into year-end. We expect activity to return in the new year, but 2022 should be slower overall relative to the record-breaking 2021.
\nJohn Yovanovic, CFA
Head of High Yield
Portfolio Management
CS 2.6 (-0.4)
\nFundamentals: Fundamentals are largely unchanged from last month, remaining solid but facing stiffer comparisons as we shift into a mid-cycle recovery. The default rate remains very low, at 0.83% (JP Morgan as of 30 November). We expect default rates to remain around 1% into 2022. Rising labor and input costs continue to be noted by management teams, but companies generally are getting price increases to compensate, in some cases with incremental margin.
\nValuations: Omicron-related volatility caused Bloomberg US Corporate High Yield Bond Index spreads to move out to 340 bps at the end of November before rapidly retreating to the 300-310 range (Bloomberg as of 16 December). We continue to believe that fair-value option-adjusted spreads (OAS) are in the 270-300 bps range due to positive fundamentals and our 1% default rate forecast. Our spread model continues to suggest annual returns of 4% to 5%. Carry remains king. BB and B credits remain favored, and first-time issuers continue to provide value opportunities.
\nTechnicals: Primary issuance set a record of over $515 billion in 2021. Volatility led to four-week rolling outflows of $1.5 billion, reversing inflows of November and leading to year-to-date (YTD) outflows of $16.5 billion. Given our view of marginally higher interest rates and less accommodative central banks, we expect relatively neutral retail flows and lower but positive institutional inflows in 2022. (Technicals based on JP Morgan Securities data as of 10 December.)
\nLaila Kollmorgen, CFA
Portfolio Manager, CLO Tranche
CS 2.6 (-0.4)
\nFundamentals: Tail-risk metrics for loans in the CLO portfolio have continued to improve through 2021 and are currently at record lows, with the share of loans under $80 currently below 2%, indicating that default rates (currently at 0.2%) will remain low in the near term. The S&P 12-month trailing speculative-grade default rate was 2.0% in October, down from 6.6% in January. (Fundamentals based on S&P Global Research as of 14 December.)
\nValuations: BBBs are at 236 to 425, BBs at 585 to 770, and single-Bs at 750 to 1,000. BBB rated CLOs are fair value compared to the OAS of 304 on high yield (HY) and 300 on BB rated leveraged loans. BB rated CLOs are trading wide of single-B HY at 337 and leveraged loans (415) on an OAS basis. The three-month cross-currency Japan yen/US dollar basis is approximately -24 bps as of 14 December 2021, roughly unchanged over the month. (Valuations based on Bloomberg and S&P/LCD data as of 14 December.)
\nTechnicals: CLO supply is slowing into year-end, which is supportive of spreads into the end of 2021 and the beginning of 2022. We do not anticipate any issues with regard to the Libor-SOFR transition.
\nEvangeline Lim
Portfolio Manager,
European Leveraged Finance
CS 2.7 (unchanged)
\nFundamentals: Purchasing managers’ index (PMI) data showed growth reaccelerating in November, reflecting resilience in the service sector which masked the drag of supply-related constraints and price pressure in the manufacturing sector. But the vibrancy is likely to be short-lived. In the near term, omicron will inevitably slow the pace of recovery as social restrictions are implemented or tightened across Europe. A severe disruption of the recovery, however, seems less likely for now. Omicron also is likely to widen growth-rate differences among European economies, reflecting the variance in vaccination rates and reliance on manufacturing. We do not expect omicron to cause a spike in defaults.
\nValuations: Loans look attractive in the current environment, where there is persistent noise from rates.
\nTechnicals: The primary issuance market has shut down earlier than usual after an intensely busy year; through November, YTD volume surpassed full-year volumes for 2019 and 2020 combined. There continues to be healthy demand from newly issued CLOs and CLO warehouses. Absent a wave of risk sell-off in the first weeks of January, we expect technicals to be strong and to potentially drive the resurgence of repricing activity.
\nEvangeline Lim
Portfolio Manager,
European Leveraged Finance
CS 3.0 (unchanged)
\nFundamentals: PMI data showed growth reaccelerating in November, reflecting resilience in the service sector which masked the drag of supply-related constraints and price pressure in the manufacturing sector. But the vibrancy is likely to be short-lived. In the near term, omicron will inevitably slow the pace of recovery as social restrictions are implemented or tightened across Europe. A severe disruption of the recovery, however, seems less likely for now. Omicron also is likely to widen growth-rate differences among European economies, reflecting the variance in vaccination rates and reliance on manufacturing. We do not expect omicron to cause a spike in defaults.
\nValuations: While current valuations appear attractive due to improving fundamentals and low default-rate expectations, they are being somewhat offset by an expected rise in volatility in 2022. The impact of the expected retreat of the quantitative easing program and healthy new-issue supply is likely to more than offset the impact of rising stars leaving the index.
\nTechnicals: Considering the outflow in the first week of December, technicals held up reasonably well, suggesting the availability of cash amid a slowdown in new-issue supply. Demand for bonds with a high coupon or low cash price appear supported by demand from CLO rampers and credit opportunity funds.
\nLaila Kollmorgen, CFA
Portfolio Manager, CLO Tranche
CS 2.6 (-0.4)
\nFundamentals: European CLO fundamentals remain healthy and the default outlook remains low.
\nValuations: BBBs are at 295 to 400, BBs at 550 to 670, and single-Bs at 690 to 900. BBB rated CLOs are cheap to BB rated HY at 250 and leveraged loans, while BB CLOs (at 328) are cheap to European HY and leveraged loan single-Bs. European CLOs benefit from a Euribor floor of zero, which adds about 60 bps to their yield. The current euro/US dollar three-month swap, at about -14 bps, means that European CLO tranches remain attractive vis-à-vis US CLOs. (Valuations based on Bloomberg and S&P/LCD data as of 14 December.)
\nTechnicals: We expect spreads to be well supported into year-end. Supply should pick up in January, reinforcing the technical backdrop that we’ve observed throughout 2021.
\nSteven Cook
Co-Head of Emerging
Markets Fixed Income
CS 2.5 (unchanged)
\nFundamentals: From JP Morgan’s tracking of 250 companies that have reported third-quarter results, revenues increased 21% YTD, EBITDA was up 32%, capex up 9%, gross debt was up 2%, and net debt was down 2%. Gross leverage declined to 2.7x from 3.6x at year-end 2020 and net leverage to 1.5x from 3.1x. Investment grade last-12-month net leverage stands at 1.2x (versus 1.6x at year-end 2020) and HY at 2.3x (versus 3.3x). Expectations are for a slight improvement in the fourth quarter and similar leverage levels next year. (Fundamentals based on JP Morgan data as of 13 December.)
\nValuations: The CEMBI BD spread-to-worst widened 16 bps on the month to 280 bps, with HY (wider by 24 bps) underperforming IG (wider by 7 bps). Through mid-month, HY retraced half of the widening seen in November, with most countries tightening except Turkey and China, driven by defaults in the property sector. We retain our bullish scores given that the market is currently mispricing the default risk on our coverage in Asia and because sovereign-driven moves elsewhere are creating value opportunities given the strong corporate fundamentals and outlook. (Valuations data from JP Morgan as of 15 December.)
\nTechnicals: YTD issuance has reached $529 billion gross and $70 billion net. Gross issuance in 2022 is expected to be similar, but net issuance is expected to be virtually flat at $3 billion, compared to net issuance of $60 billion-$90 billion annually over the last three years. The only region expected to have positive net issuance is the Middle East, at $34 billion. We maintain our scores given muted supply expectations, fund flows that have been relatively unaffected, and continuing new allocations to the asset class. (Technicals based on JP Morgan data as of 13 December.)
\nLeveraged Finance Asset Allocation Insights is a monthly publication that brings together cross-sector views within our leveraged finance fixed income group. Our global team of investment professionals convenes in a live forum to evaluate, debate, and establish top-down guidance for the asset classes that make up the leveraged finance investment universe. Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the leveraged finance market.
\nThe information presented herein is for illustrative purposes only, represents a general assessment of the markets at a specific time, and is not a guarantee of future performance results or market movement. It does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; or a recommendation for any investment product or strategy. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. PineBridge Investments does not approve of or endorse any republication of this material. In addition, the views expressed may not be reflected in the strategies and products that PineBridge offers.
","custom_s_image_alt":"Leveraged Finance Asset Allocation Insights: Will December’s Whiplash Make Way for Calmer Markets in 2022?","custom_s_image":"/_assets/images/articles/article-cover-images/2021/12-lfaai-dec-2021.jpg","custom_ss_authors":["80188"],"custom_ss_author_links":["/bio/oh-steven"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"After head-spinning market moves in December, we expect downside risks related to omicron to fade in early 2022 and continue to see attractive issuer-level opportunities in high yield bonds and leveraged loans.","custom_s_local_url":"/en/investor-types/default/insights/leveraged-finance-asset-allocation-insights-will-decembers-whiplash-make-way-for-calmer-markets-in-2022","score":1.0},{"id":"180286","custom_i_asset_id":180286,"custom_s_title":"Fixed Income Asset Allocation Insights: Market Jitters Shouldn’t Detract from Strong Fundamentals","custom_dt_date":"2021-12-07T00:00:00Z","custom_s_description":"Most credit markets generated negative total returns in November. At the forefront of investors’ minds were upcoming central bank tapering efforts and growing geopolitical headwinds, while mounting inflation pressures have increased uncertainty around future monetary policy and how aggressively central banks will respond. Evidence of a new Covid wave in Europe and the global spread of the Omicron Covid variant – which we do not expect will result in the same level of shutdowns as in the early days of the pandemic – led to new restrictions and spooked investors late in the month.
\nDespite growing risks, the fundamental backdrop remains relatively strong. Third-quarter earnings were mostly positive, albeit coming with increasing input costs and forecasts of less robust growth heading into 2022. The technical backdrop also has remained largely supportive, as demand continues to be robust with issuance expected to moderate next year. In addition, despite expected tightening by central banks, current levels of accommodation continue to support markets.
\nAgainst this backdrop, our fixed income allocations remain unchanged and we continue to buy selectively. While recent spread widening in certain asset classes has created some more attractive entry points, valuations remain near fair value and will likely continue to be largely range-bound.
\n\nMarkus Schomer, CFA, Chief Economist
\nRaising the US Macro Bull Case
We raised our bull case US Macro scenario probability to 45% and lowered our central case to 40%. Our bear case is unchanged at 15% due to the risk of a new Covid flare-up and Fed policy errors.
Market movers
The Fed. Now that chair Powell is renominated, we can stop speculating about strategy changes. But can the Fed stick to Powell’s slow taper and “rate-hikes-far-off- in-the-future” plan? Nobody thinks inflation is transitory anymore, and we’re running the risk of developing a wage-price spiral. Already, some FOMC members want faster tapering and earlier rate hikes.
Fourth-quarter trends. Purchasing managers’ index (PMI) surveys flagged the US growth reacceleration early. Retail sales and industrial production confirmed that economic activity picked up again in October. Only housing was disappointing, still beset by both surging input prices and serious labor shortages. We should remain on pace for our fourth-quarter US GDP growth forecast of 5%.
Peak inflation. Oil prices started to ease, but US inflation pressures are not likely to slow substantially until next March, when base effects from the current surge kick in. Between March and October of 2021, monthly headline inflation averaged 0.6%. Anything lower than that will allow the year-over-year rate to slow. But we don’t anticipate Consumer Price Index (CPI) inflation falling back below 4% until next August or back to 2% until the summer of 2023.
For illustrative purposes only. We are not soliciting or recommending any action based on this material. There can be no assurance that the above allocations will be in any account at the time this information is presented. This material must be read in conjunction with the Disclosure Statement.
John Yovanovic, CFA, Head of High Yield Portfolio Management
\nFundamentals
Fundamentals remain solid but face harder comparisons as we shift to a midcycle recovery. Third-quarter earnings produced a continuation of across-the-board upside surprises with some small misses in the consumer, telecom, and utilities sectors. Energy results remained solid and supply discipline is holding. Management teams continue to note rising labor and input costs, but companies generally are getting price increases to compensate, in some cases with incremental margin.
Valuations
Spreads remain range-bound but resilient in the face of rising US Treasury yields. We remain in the 270-300 option-adjusted spread (OAS) target of our spread model. Spreads are fair near-term, but we continue to see merit for the asset class, which remains attractive relative to other options. At current spread levels, though, there is likely not enough cushion to fully absorb increases in interest rates. Our spread model continues to suggest 4% to 5% annual returns. Carry remains king. BB/B credit remains favored, and first-time issuers continue to provide value opportunities.
Technicals
Primary issuance continues at a moderate pace, surpassing US$500 billion for 2021, a record. Despite rates pressure, inflows have returned and technicals remain solid. Year-to-date (YTD) outflows total US$10.6 billion, which have been more than offset by institutional inflows. These trends should continue into 2022. (Technicals based on JP Morgan Securities data as of 17 November.)
We maintain our allocation of 35%. Earnings improvement is expected to slow to more normal levels from the sharp recovery earlier this year. Valuations have improved, with spreads recently trading through the top of our OAS range, but remain around fair value. We continue to favor floating-rate loans and investment grade (IG) collateralized loan obligation (CLO) debt, as we expect rates to be a headwind in 2022. Overall we still favor credit, keeping portfolio risk around a beta greater than or equal to 1.0 and maintaining relatively higher current yield and portfolio option-adjusted duration at or below index levels.
\nDana Burns, Portfolio Manager, US Dollar Investment Grade Fixed Income
\nFundamentals
With net leverage now below pre-Covid levels and rising stars expected to well outpace fallen angels in 2022, fundamentals have improved. Nevertheless, we remain concerned about margin pressure in the industrial sector due to rising input costs. The reopening of economies continues to drive demand.
Valuations
Credit spreads look more attractive given recent spread widening. We still find all-in yields and select credits and sectors attractive.
Technicals
The technical backdrop for credit has improved recently with the return of foreign demand. Low broker-dealer inventories (negative in the five- to 10-year bucket) remain. Near-term concern surrounding Fed policy may slow demand.
Roberto Coronado, Portfolio Manager, Non-US-Dollar Investment Grade Credit
\nFundamentals
Neutral. Companies in general continue to beat expectations, while net leverage is slightly below 2019 levels; balance sheets remain in good shape. We continue to monitor merger and acquisition (M&A) activity given the recent increase, but we are still comfortable with the credit metrics.
Valuations
Neutral. Credit spreads have recently widened but they are still close to fair value at the index level. We expect volatility to increase somewhat in coming weeks, albeit from very low levels. We still believe that sector and security selection are central to outperformance.
Technicals
Positive. The technical picture has remained supportive thanks to continuous buying from European Central Bank (ECB) programs and positive inflows into the asset class since the summer.
We maintain our allocation of 20%. The fundamental backdrop is largely positive and demand for credit has remained strong, but we have seen increased uncertainty in the outlook for 2022. We expect issuance to slow next year and view this as a positive technical factor against the backdrop of steady demand from foreign investors.
\nAnders Faergemann, Portfolio Manager, Emerging Markets Fixed Income
\nFundamentals
While China’s slowdown has been well telegraphed and largely priced in by financial markets, less well-known is that ASEAN countries are likely to see stronger economic growth in 2022 than in 2021. Likewise, our forecasts are showing a pickup in activity in Central and Eastern Europe next year. Above all, China now has less influence on global investments than in previous business cycles.
Valuations
Sovereign spreads have widened approximately 20 basis points (bps) in the recent wobble, yet maintain a positive tone within a narrow range of +340-360 bps over US Treasuries. The overall index is at +357 bps, IG is at +147 bps, and high yield (HY) at +611 bps. Sovereign HY spreads have widened slightly more yet continue to trade well within this year’s range of +555-628 bps over US Treasuries. (Valuations based on JP Morgan and Bloomberg data as of 19 November 2021.)
Technicals
Emerging market outflows have been modest in the face of the recent spike in market volatility. JP Morgan has scaled back on its issuance expectations of US$60 billion before year-end, in line with our predictions. We believe gross issuance will decline significantly in 2022 from 2021. Net issuance will likely be modest and centered around IG.
Steven Cook, Co-Head of Emerging Markets Fixed Income
\nFundamentals
Our scores remain unchanged. With over half the companies in the MSCI Emerging Markets index having reported third-quarter earnings, 50% beat expectations. Top-line revenue and EBITDA were up 25% and 24% year-over-year, respectively (MSCI as of 11 November). Among our covered companies, 32% beat analyst expectations and only 5% of those that have reported have a negative six-month credit outlook.
Valuations
Spread-to-worst on the CEMBI BD was virtually flat at 264 bps, with HY (up 11 bps) underperforming IG (down 5 bps) (JP Morgan as of 17 November). HY performance was driven by a 256-bp move wider on the month (which was retraced by 252 bps late in November) due to China’s property sector woes. We retain our bullish scores given that the market is currently mispricing the default risk on our coverage in Asia and because we believe there is limited contagion risk to the broader market, offering a spread pickup versus other asset classes.
Technicals
With $19 billion of supply through mid-month, issuance declined overall but picked up slightly in Asia, accounting for 44% of the total. Net issuance of $294 billion YTD is in line with full-year expectations, so we expect limited issuance into year-end. On muted supply expectations and fund flows that haven’t changed significantly, we still see new allocations to the asset class. (Technicals based on JP Morgan data as of 15 November.)
We maintain our allocation of 25%. EM investors are used to noisy headlines and market trepidation, yet risks related to China and the Fed are known, and emerging markets are in better shape than during previous periods of volatility. Spreads are attractive on a relative basis and fundamentals remain strong, yet the time of year may warrant some caution on technicals. As a result, we continue to buy selectively.
\nAndrew Budres, Portfolio Manager, Securitized Products
\nFundamentals
Fundamentals are still challenging. Mortgage rates are headed higher, but originators have no shortage of lower-quality borrowers brushed aside during high-production months or customers looking to refinance via cash-out products.
Valuations
Spreads have already been taking into consideration an imminent taper. Higher rates or steeper curves should be good for mortgage-backed securities (MBS) spreads.
Technicals
MBS supply will be much lower in 2022 than in the record year of 2021, but a hot housing market will keep the mortgage churn going as home sales spur refinancings and new loans.
We maintain our allocation of 20%. MBS performance since September has been correlated to rates movements, not Fed tapering. Any rumors about faster tapering most likely would impact MBS valuations negatively, as doing so probably could be accomplished more easily via MBS operations rather than Treasury operations. Against this backdrop, we are neutral to slightly cautious for the asset class.
\nDmitri Savin, Portfolio Manager, Portfolio and Risk Strategist, Emerging Markets Fixed Income
\nFundamentals
Decoupling of policy expectations between the Fed and the ECB/ Bank of Japan have become more prominent in recent months, accentuating the current upward trend in the US dollar against the euro and the Japanese yen, which also have been beset by terms of trade factors.
Valuations
We have moved our euro/US dollar forecast to 1.1250 within a range of 1.1000-1.1500 for the next 12 months. We are slightly long the US dollar and underweight the euro. We have changed our 12-month forecast range for US dollar/Japanese yen to 112.50-117.50. We are neutral the yen.
Technicals
According to JP Morgan and International Monetary Market data through 15 November, net US dollar length is currently +$18.6 billion, equivalent to +0.8 standard deviations above five-year averages. However, it appears there is still room for the US dollar to gain in the context of a more open-minded Fed.
We maintain our 0% non-dollar allocation. While the technical break of 1.1500 in the euro/US dollar has opened the possibility of the pair moving lower faster than expected a month ago, we want to flag positioning and seasonal factors as potential triggers for a December reversal. Fundamentals and technicals justify an extension of the US dollar appreciation trend.
\nSource: PineBridge Investments. For illustrative purposes only. Any opinions, projections, forecasts and forward-looking statements are based on certain assumptions (which may differ materially from actual events and conditions) and are valid only as of the date presented and are subject to change.
\n\nFixed Income Asset Allocation Insights is a monthly publication that brings together the cross-sector fixed income views of PineBridge Investments. Our global team of investment professionals convenes in a live forum to evaluate, debate, and establish top-down guidance for the fixed income universe. Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the global fixed income market.
","custom_s_image_alt":"Market Jitters Shouldn’t Detract from Strong Fundamentals","custom_s_image":"/_assets/images/articles/article-cover-images/2021/12-fiaat-23-nov-2021.jpg","custom_ss_authors":["80545"],"custom_ss_author_links":["/bio/vanden-assem-robert-cfa"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"Despite some market skittishness amid renewed Covid waves and inflation pressures, the fundamental backdrop remains relatively strong, and we continue to buy selectively.","custom_s_local_url":"/en/investor-types/default/insights/fixed-income-asset-allocation-insights-23-november-2021","score":1.0},{"id":"179577","custom_i_asset_id":179577,"custom_s_title":"Leveraged Finance Asset Allocation Insights: Technicals Support Loans as CLO Issuance Surges","custom_dt_date":"2021-12-01T00:00:00Z","custom_s_description":"Credit-spread performance in leveraged finance asset classes was mixed in November. While news of the omicron Covid variant rattled markets late in the month, high yield spreads broadly traded flat to slightly wider as optimism around mostly solid third-quarter earnings was offset by volatility in Treasury rates and higher-than-expected October Consumer Price Index (CPI) numbers, driven by rising energy, shelter, and auto prices, exacerbating inflation worries. Floating-rate bank loans fared modestly better: Technical conditions remain extremely supportive as retail flows into mutual funds and exchange-traded funds (ETFs) rose to their highest levels since spring and collateralized loan obligation (CLO) issuance continued at a blistering pace after posting three consecutive monthly records.
\nLooking ahead, we remain constructive on both asset classes and continue to find attractive total return opportunities at the issuer level. While inflation is likely to trend above 2% for some time, we expect it ultimately will prove transitory, as it has been driven by supply-chain bottlenecks, labor shortages, and related supply-demand imbalances. With transportation, food, and housing accounting for 70% of the US CPI basket, signs of subsiding pricing pressure in those categories in recent weeks have been encouraging.
\nWhile we have been active in the new-issue market for both leveraged loans and high yield bonds, we maintain a slight preference for loans. We continue to see a supportive technical backdrop for loans as retail investors, anticipating increases in federal funds rates, are attracted to the floating-rate nature of the asset class. We also expect CLO issuance to remain robust. We have been active in select CLO new issuances, favoring investment grade CLO debt tranches that are being issued with yields comparable to single-B rated bank loans.
\nThe following sections reflect the investment team’s views on the relative attractiveness of the various segments of below-investment-grade corporate credit. Conviction scores are assigned on a scale from 1 to 5, with 1 being the highest conviction.
\nKevin Wolfson
Portfolio Manager,
US Leveraged Loans
CS 2.8 (unchanged)
\nFundamentals: With most issuers continuing to report year-over-year (y/y) earnings growth despite supply chain constraints and inflation, fundamentals remain generally positive for US loan issuers. Leverage for the broader loan market continues to move down, although total leverage has been on the rise in recent new issues. If the trend continues, it could lead to increased market risk longer term. For now, however, default rates remain near all-time lows with the last-12-month (LTM) default rate of the S&P LSTA Leveraged Loan Index at roughly 0.20% as of 17 November. Given ample market liquidity, we expect defaults to remain well below their historical average over the near to medium term.
\nValuations: Although loan yields don’t appear overly compelling on an absolute basis, spreads remain relatively attractive on a risk-adjusted basis. The spread-to-maturity for the S&P/LSTA Leveraged Loan Index was relatively unchanged month over month, tightening by only 1 basis point (bp) from 19 October to 17 November. Single-B spreads came in 2 bps over this time period, while BB and CCC spreads widened 2 bps and 8 bps, respectively.
\nTechnicals: The technical backdrop in the US loan market remains positive, with demand continuing to outpace strong new issuance. US CLO managers priced $13 billion of new CLOs month-to-date in November, which, coupled with the continuation of positive retail fund flows, has more than offset the large volume of loans coming to market. Issuance is being driven not only by mergers and acquisitions (M&A) and leveraged buyout activity but also by dividend recapitalizations. The net forward calendar for loans remains robust with roughly $45 billion in the pipeline, an increase of just over $6 billion from the week prior. (Technicals based on S&P LCD data as of 17 November.)
\nJohn Yovanovic, CFA
Head of High Yield
Portfolio Management
CS 3.0 (unchanged)
\nFundamentals: As we shift to a mid-cycle recovery, fundamentals remain solid. Third-quarter earnings produced a continuation of across-the-board upside surprises with some small misses in the consumer, telecom, and utilities sectors. Energy results remained solid and supply discipline is holding. Management teams continue to note rising labor and input costs, but companies generally are getting price increases to compensate, in some cases with incremental margin.
\nValuations: Spreads remain rangebound but resilient in the face of rising US Treasury yields. We remain in the 270-300 option-adjusted-spread (OAS) target of our spread model. Spreads are fair near-term, but we continue to see merit as the asset class remains attractive relative to other options. At current spread levels, though, there is likely not enough cushion to fully absorb increases in interest rates. Our spread model continues to suggest 4% to 5% annual returns. Carry remains king. BB/B credit remains favored, and first-time issuers continue to provide value opportunities.
\nTechnicals: Primary issuance continues at a moderate pace, surpassing $500 billion for 2021, a record. Despite rates pressure, inflows have returned and technicals remain solid. Year-to-date (YTD) outflows total $10.6 billion, which have been more than offset by institutional inflows. These trends should continue into 2022. (Technicals based on JP Morgan Securities data as of 17 November.)
\nLaila Kollmorgen, CFA
Portfolio Manager, CLO Tranche
CS 3.0 (+0.4)
\nFundamentals: Tail-risk metrics for loans in the CLO portfolio have continued to improve through 2021 and are currently at record lows, with the share of loans under $80 currently below 2%, indicating that default rates (currently at 0.2%) will remain low in the near term. The share of broadly syndicated loans rated CCC by S&P is at 5% (down three percentage points YTD), driven primarily by upgrades over the past few quarters. CCC loan prices have continued to improve on the back of potential upgrade/refi activity. (Fundamentals based on S&P Global Research as of 17 November.)
\nValuations: BBBs are at 250 to 425, BBs at 545 to 755, and single-Bs at 700 to 1,000. BBB rated CLOs are fair value compared to the OAS of 285 on high yield (HY) and to BB rated leveraged loans at 300. BB rated CLOs are trading wide of single-B HY (319) and leveraged loans (417) on an OAS basis. The three-month cross-currency Japan yen/US dollar basis is approximately negative 24 bps as of 16 November, roughly unchanged over the month. Currently, US dollar assets are at their least attractive YTD for Japanese buyers. (Valuations based on Bloomberg and S&P/LCD data as of 17 November.)
\nTechnicals: CLO supply remains heavy but more uncertainties will start looming closer to year-end, with unknowns like the depth of demand for Libor-linked CLOs versus those linked to SOFR. Once the first few SOFR-linked deals print, we expect CLO demand to persist at 2021 rates, especially as rate hikes continue to creep into scope.
\nEvangeline Lim
Portfolio Manager,
European Leveraged Finance
CS 2.7 (unchanged)
\nFundamentals: The business outlook remains favorable across major European economies despite ongoing energy-led cost inflation and renewed Covid restrictions. Private-sector employment and wage growth are expected to remain healthy while inflationary pressure is expected to be transitory. Amid rising Covid cases, uncertainties about the new omicron variant, and the perceived fragility of the European economic recovery, the European Central Bank is expected to maintain its dovish stance. Third-quarter earnings have been broadly positive, with most issuers reporting recovery in top- and bottom-line growth. A small proportion of issuers are reporting margin erosion due to a price surge in raw materials.
\nValuations: Nominal spreads are at their widest since 2017. In expectation of a continuing low-default environment, valuations look attractive, in our view.
\nTechnicals: Issuance has picked up since late October, with launches more evenly paced than in the first and second quarters. New-issue supply continued to be well absorbed by ramping CLO vehicles, while new-issue spreads remained stable. Demand for loans has been slightly moderated by the easing of pressure to replace portfolio assets due to postponement of planned IPOs. Repricing activities have been muted.
\nEvangeline Lim
Portfolio Manager,
European Leveraged Finance
CS 3.0 (unchanged)
\nFundamentals: The business outlook remains favorable across major European economies despite ongoing energy-led cost inflation and renewed Covid restrictions. Private-sector employment and wage growth are expected to remain healthy while inflationary pressure is expected to be transitory. Amid rising Covid cases, uncertainties about the new omicron variant, and the perceived fragility of the European economic recovery, the European Central Bank is expected to maintain its dovish stance. Third-quarter earnings have been broadly positive, with most issuers reporting recovery in top- and bottom-line growth. A small proportion of issuers are reporting margin erosion due to a price surge in raw materials.
\nValuations: European HY looks attractive compared to US HY due to a difference in interest rate trajectories. Compared to European loans, the picture is mixed, with BB rated bonds looking expensive and lower-rated bonds looking attractive.
\nTechnicals: As new issues slowed and rates fears abated over the last few weeks, technicals firmed. In addition, many recent new issues were BB rated, attracting traditional investment grade (IG) investors.
\nLaila Kollmorgen, CFA
Portfolio Manager, CLO Tranche
CS 3.0 (unchanged)
\nFundamentals: European CLO fundamentals remain healthy as portfolio net asset values generally improved over the month and the default outlook continues to be low.
\nValuations: BBBs are at 275 to 350, BBs at 530 to 640, and single-Bs at 755 to 955. BBB rated CLOs are cheap compared to BB rated HY (243) and leveraged loans (351), while BB rated CLOs are cheap to European single-B HY (399) and leveraged loan single-Bs (448). European CLOs benefit from a Euribor floor of zero, which adds about 57 bps to the yield of European CLOs. The current euro/US dollar three-month swap, at about negative 23 bps, means that European CLO tranches remain attractive vis-à-vis US CLOs. (Valuations based on Bloomberg and S&P/LCD data as of 17 November.)
\nTechnicals: Heavy supply in the primary market currently weighs on mezzanine spreads, but AAA spreads continue to tighten. We expect a slowdown in issuance toward year-end and a pickup in demand as US investors look abroad due to Libor-SOFR transition risks, keeping spreads range-bound.
\nSteven Cook
Co-Head of Emerging
Markets Fixed Income
CS 2.5 (unchanged)
\nFundamentals: Our scores remain unchanged midway through the third-quarter reporting period. With over half the companies in the MSCI Emerging Markets (EM) index having reported, 50% beat expectations. Top-line revenue and EBITDA were up 25% and 24% y/y, respectively (MSCI as of 11 November). Among our covered companies, 32% beat analyst expectations and only 5% of the names that have reported have a negative six-month credit outlook.
\nValuations: Spread-to-worst on the CEMBI BD was virtually flat on the month at 264 bps, with HY (up 11 bps) underperforming IG (down 5 bps) (JP Morgan as of 17 November). HY performance was driven by a 256-bp move wider on the month (which was retraced by 252 bps late in November) due to issues in China’s property sector. We retain our bullish scores given that the market is currently mispricing the default risk on our coverage in Asia and because we believe there is limited contagion risk to the broader market, offering a spread pickup versus other asset classes.
\nTechnicals: Issuance dropped off this month, with $19 billion of supply month-to-date (MTD) versus an average of $36 billion for November. Issuance has picked up slightly in Asia, accounting for 44% of supply MTD (versus 58% YTD). Net issuance of $294 billion YTD is in line with full-year expectations, so we expect limited issuance into year-end. On muted supply expectations and fund flows that haven’t changed significantly, we still see new allocations to the asset class. (Technicals based on JP Morgan data as of 15 November.)
\nLeveraged Finance Asset Allocation Insights is a monthly publication that brings together cross-sector views within our leveraged finance fixed income group. Our global team of investment professionals convenes in a live forum to evaluate, debate, and establish top-down guidance for the asset classes that make up the leveraged finance investment universe. Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the leveraged finance market.
\nThe information presented herein is for illustrative purposes only, represents a general assessment of the markets at a specific time, and is not a guarantee of future performance results or market movement. It does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; or a recommendation for any investment product or strategy. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. PineBridge Investments does not approve of or endorse any republication of this material. In addition, the views expressed may not be reflected in the strategies and products that PineBridge offers.
","custom_s_image_alt":"Leveraged Finance Asset Allocation Insights: Technicals Support Loans as CLO Issuance Surges","custom_s_image":"/_assets/images/articles/article-cover-images/2021/11-lfaai-nov-2021.jpg","custom_ss_authors":["80188"],"custom_ss_author_links":["/bio/oh-steven"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"While news of the omicron Covid variant rattled markets late in November, high yield spreads broadly traded flat to slightly wider, and technical conditions remain highly supportive of floating-rate bank loans, with retail flows into mutual funds and ETFs rising to their highest levels since spring and CLO issuance at a blistering pace. ","custom_s_local_url":"/en/investor-types/default/insights/leveraged-finance-asset-allocation-insights-technicals-support-loans-as-clo-issuance-surges","score":1.0},{"id":"147998","custom_i_asset_id":147998,"custom_s_title":"Why ESG Is Critical in Asian Fixed Income Investing","custom_dt_date":"2021-11-30T00:00:00Z","custom_s_description":"Asia occupies a unique spot at the intersection of sustainability and finance. It is home to 60% of the world’s population, two of the world’s top three energy-consuming countries, and a growing trillion-dollar credit market.1 At the same time, 99 of the 100 riskiest cities for environmental and climate-related threats are in Asia.2 In recent years, the region’s largest economies have announced timelines toward carbon neutrality, measures to reduce greenhouse gas emissions, and investments in cleaner energy sources, electric vehicles, and other green technologies in a bid to stem climate change.
\nThe United Nations estimates that Asia-Pacific requires an additional investment of US$1.5 trillion annually to meet the Sustainable Development Goals by 2030.3 Reflecting the financing gap and the regulatory push, Asia saw a surge in issuance of environmental, social, and governance (ESG)-related bonds in 2021. These bonds offer opportunities for international investors to gain exposure to a new potential alpha source in Asia fixed income. When the Hong Kong government issued US$2.5 billion in green bonds in 2021, European and US investors cornered a third of the total issuance.4
![\"2021:](\"/_assets/images/articles/charts/11-why-esg-is-critical-in-asian-fixed-income-investing-nov-21-1.gif\")
Source: JPMorgan as of 30 September 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
This investment environment presents exciting new frontiers. On one hand, capital dedicated toward ESG investments is growing; on the other, opportunities for capital appreciation increase as companies bridge ESG gaps. For now, it is a case of large amounts of money chasing few assets, which could lead to disappointment if investors are not carefully vetting the ESG processes of the underlying businesses they’re investing in and the securities selectors they’re engaged with.
\nThe integration of ESG factors into investment processes is still relatively new in Asia compared to the US and Europe, given a limited understanding of its benefits and a relative lack of commercial motivation, among other reasons. Yet our experience investing in Asian fixed income for nearly two decades has shown that ESG factors have a measurable impact on outcomes in areas such as credit quality, defaults, and spreads. In times of financial stress, like today, investing with an ESG lens can help fortify portfolios through heightened risk management – and active investing using local expertise and an on-the-ground presence offers the added advantage of a more nuanced approach to identifying risks and opportunities.
\nHere we provide practical insights into how ESG influences our Asia fixed income investment decisions and our views of some emerging trends in the region.
\nRegulations and institutional investor demand are the main drivers of environmental considerations in Asia. In certain sectors (including energy, metals and mining, and utilities, among others), environmental factors play an increasingly critical role due to growing awareness of climate change and sustainable financing. For example, the Asian palm oil industry, which produces the bulk of global supply, has been subject to scrutiny for its alleged role in deforestation and destruction of wildlife, and in recent years, large institutional investors have divested their holdings in the sector. Bonds of Asian palm oil companies have seen periods of volatility following negative news. In 2018, we passed on a maiden bond offering of an Asian palm oil company because of its noncompliance with industry sustainability standards. The bond has been trading at distressed levels since 2019.
\nStaying on top of environmental regulatory changes is key in Asia. In recent years, the Chinese government has put greater emphasis on sustainable growth, including imposing stricter environmental regulations. Companies’ noncompliance could be costly and pose an investment risk. In addition, Asia’s pivot to renewable energy has created opportunities in fixed income. We participated in an issue by one of the largest pure-play renewable energy generation platforms in India. With renewable energy a key priority for the Indian government, supportive regulatory measures in recent years have been positive for the bonds. Several international long-term investors also became shareholders, providing capital to support growth.
\nSocial factors typically have a small, short-term impact on businesses; however, social policies have taken greater priority in some governments’ agendas. China’s pivot toward “common prosperity” policies in 2021 underscored the focus on sustainable and fair business practices. While the policies have upturned the after-school tutoring and online gaming industries, as well as the economically important property sector, over the long term, sectors and businesses aligned with these new policies are expected to benefit from opportunities.
\nEven before these new policies, we saw how a strong social focus can translate to investment opportunities. For instance, we invested in one of the largest urban rail systems in China, which has an estimated average daily ridership of 10 million. Ticket prices are set low, with the company putting greater emphasis on its mandate of providing a public good. While we tend not to favor Chinese local government financing vehicles given their sometimes weak financial profiles, this company had a high ESG score. It maintains a strong safety record and a good relationship with its workforce. The bonds’ spread remains stable compared to top-tier state-owned enterprises.
\nMore recently, amid the Covid-19 outbreak, a privately owned Chinese express delivery company put considerable effort into ensuring employees’ health and safety at its own expense, such as by providing sanitation facilities, masks, and quarantine spaces. It also demonstrated greater social impact by transporting essential goods to the healthcare sector and to help support people’s livelihoods. Despite broader disruptions in the logistics industry, the company’s delivery capability remained strong because of its extensive, self-owned network. The market appears to recognize this: The spread of the company’s bonds continues to be close to those of similarly rated state-owned enterprises.
\nThe private sector is also beginning to tap the social bonds market. In November 2021, a Thai food company launched the first social bond by a nonfinancial corporate issuer under the Association of Southeast Asian Nations (ASEAN) social bond standards. Meanwhile, foreign entities are now allowed to issue yuan-denominated bonds for social responsibility and sustainability projects in China’s large onshore bond market.
\nThe governance element continues to be a major focus in Asia, mainly because of the large number of issuers that are government-owned, family-owned, or part of intricate cross-shareholdings. We believe a proper assessment of corporate governance is critical in Asian fixed income investing. For example, the ownership structure can have direct implications on default risk. We encountered a case where an issuer marketed itself as a “state-owned enterprise” during a bond roadshow, but then declined to discuss details of the formation of its board of directors. State-owned enterprises may offer creditors added confidence in the form of a potential backstop or an implicit guarantee by the parent entity in the event of financial difficulties or default. This also allows the issuer to price bonds at a tighter spread. In this case, however, we found that the issuer’s shareholding structure was complex and determined that the company does not meet the definition of a state-owned firm. Our analysis led us to pass on the bonds, which later defaulted.
\nMoreover, governance-related lapses have cost bondholders in Asia billions of dollars over the years. One notable case in the past decade involved a Hong Kong-listed Chinese timber company, whose CEO and controlling shareholder was found to have embezzled millions from the company. Its management also admitted to fabricating the company’s assets and revenues. The company defaulted three months after it issued a US dollar bond.
\nThe examples above illustrate the need for a more deliberate ESG analysis, which we view as critical for robust risk management. Our global emerging market (EM) fixed income team’s ESG process generates proprietary quantitative risk scores at the country, sector, and issuer levels (the higher the score, the higher the ESG risk), based on nine categories. The integration of ESG scores into our common global credit analysis platform and portfolio management tools allows the team to analyze ESG risk over time. Analyst input also plays an important role in accurately assessing these ESG risks, and ultimately in promoting better security selection. More than one analyst will cover a sector, adding further rigor to the process. The chart below shows the disparity in ESG scores by market and sector, reflecting the different stages of ESG development in Asia.
![\"Our](\"/_assets/images/articles/charts/11-why-esg-is-critical-in-asian-fixed-income-investing-nov-21-2.gif\")
Source: PineBridge Investments as of 24 May 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any views represent the opinion of the investment manager and are subject to change.
Asia is narrowing the gap with other regions in ESG. Market regulators and securities exchanges have established a variety of requirements for ESG disclosures for listed companies. China is now one of the largest green bond markets in the world, while Hong Kong issued the first long-dated sovereign green bond in 2021, with a 30-year tenor, which is viewed as key in building a comprehensive benchmark curve for future issuers in Asia.
\nYet challenges remain. For now, we have yet to see a consistent green/ESG bond premium in Asia green bonds. Sustainability-linked bond issuances are a positive development, but issuers often have below-average ESG characteristics and have set out sustainability targets, which, if not met, could result in a coupon step-up at a specific year (usually close to the final year). While the bonds sound good on paper, in our view most issuers thus far have either unambitious targets or negligible, non-punitive coupon step-up provisions, which offer limited additional incentive to work toward achieving those targets. We believe greater scrutiny from the investor community will be needed to make the targets and compensation more meaningful.
\nInvestors also still face some hurdles in Asia, including the alignment of domestic “green” definitions with international principles, limited diversity of the types and sectors of issuers, and limitations related to transparency and credit ratings.
\nThat said, we expect growing investor interest in sustainable investing in Asia will drive greater focus on ESG for issuers, investors, and asset managers, boosting the case for alpha from ESG in Asia fixed income.
1 Sources: Population: UN Department of Economic and Social Affairs, World Population Prospects 2019; Energy: BP Statistical Review of World Energy 2021; Market Size: JP Morgan, PineBridge as of 30 September 2021.
2 Verisk Maplecroft, “Asian cities in eye of environmental storm – global ranking,” May 2021. See: https://www.maplecroft.com/insights/analysis/asian-cities-in-eye-of-environmental-storm-global-ranking/
3 UNESCAP, 2019 https://www.unescap.org/sites/default/d8files/knowledge-products/Economic_Social_Survey%202019.pdf
4 Hong Kong Monetary Authority, 27 January 2021. See: https://www.hkma.gov.hk/eng/news-and-media/press-releases/2021/01/20210127-3/
Investing involves risk, including possible loss of principal. The information presented here-in is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"Why ESG Is Critical in Asian Fixed Income Investing","custom_s_image":"/_assets/images/articles/article-cover-images/2020/09_why-esg-is-critical-in-asian-fixed-income-investing-sept-2020.jpg","custom_ss_authors":["80377"],"custom_ss_author_links":["/bio/lau-arthur-cfa"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"In our experience, ESG factors have demonstrated a measurable impact on Asian fixed income outcomes, in areas such as credit quality, defaults, and spreads. In times of financial stress like today, investing with an ESG lens can help fortify portfolios through heightened risk management. ","custom_s_local_url":"/en/investor-types/default/insights/why-esg-is-critical-in-asian-fixed-income-investing","score":1.0},{"id":"179423","custom_i_asset_id":179423,"custom_s_title":"High Quality Asia Bonds Offer Stability and Yield Amid Fixed Income Flux","custom_dt_date":"2021-11-30T00:00:00Z","custom_s_description":"High quality Asia bonds will likely continue to attract yield seekers amid uncertain markets. The hard currency investment grade (IG) segment, which makes up nearly 80% of the market, offers distinct advantages compared to developed market peers, making these bonds compelling diversifiers in global portfolios.1
Arthur Lau, Head of Asia ex Japan Fixed Income, and Omar Slim, Senior Portfolio Manager, Asia Fixed Income, answer questions about opportunities in Asia IG bonds and the sector’s prospects and potential risks.
Given recent bond market volatility, how do you expect Asia IG bonds to perform in the months to come?
\nLau: We believe conditions remain ripe for Asia IG’s continued strong performance this year with the region’s economies poised to progressively open up. Asia IG bonds have been insulated from recent credit scares, and we are expecting a greater dispersion of returns within the IG space. One obvious example is the divergence between the Chinese real estate issuers and the rest of the Asian segments, which so far have been almost entirely spared from spread widening. We expect the epicenter of weakness from the Chinese real estate market to remain in the high yield segment, although some volatility may radiate to weaker Chinese real estate investment grade names.
Source: JPM, Bloomberg, PineBridge Investments as of 30 September 2021. Asia IG Credit Spread represented by JPM JACI Investment Grade Index. For illustrative purposes only. Any opinions, projections, forecasts, or forward-looking statements presented are valid only as of the date indicated and are subject to change. We are not soliciting or recommending any action based on this material. Past performance is not indicative of future results.
Slim: Broadly speaking, credit metrics in Asia, such as corporate net leverage have remained relatively low compared to US, Latin America, and other emerging markets, while interest coverage ranked highest relative to these three regions.2 That, along with a stable Asian institutional investor base should anchor credit spreads.
What benefits can Asia IG bonds offer a global portfolio?
\nLau: Asia IG offers better yield than investment grade bonds in other regions, while duration is shorter,3 offering a buffer against rising interest rates. In terms of diversification, Asia IG offers a higher Sharpe ratio4 than US bonds, US inflation-linked, and global equities. It also offers exposure to China and the rising economies of South and Southeast Asia that still remain underrepresented in global bond indexes. A stable regional institutional investor base could potentially dampen volatility.
Source: Bloomberg, PineBridge Investments as of 30 September 2021. Asian IG is represented by JACI Investment Grade, US IG by the Bloomberg Barclays US Credit Index and Global Agg Credit IG: Bloomberg Barclays Global Aggregate Index. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Past performance is not indicative of future results.
Source: Bloomberg, rolling five-year data as of 30 September 2021. *Sharpe ratio is the most common measure for calculating risk-adjusted return for a fund. The Sharpe ratio is the average return earned in excess of the risk-free rate per unit of risk (volatility). The higher the Sharpe ratio, the better the returns compared to the risk taken. In this chart, commodities are represented by the Bloomberg Commodity Index, Asia USD Bonds by the JPM JACI index, Emerging Markets (USD) by the JPM EMBI Global Diversified index, US IG Credit by Bloomberg Barclays US Aggregate Index, US High Yield by Bloomberg Barclays US High Yield index, US Inflation Linked by Bloomberg Barclays US Inflation Linked index, US Equities by S&P 500 index, and Asia ex Japan Equities by the MSCI MXASJ index. Diversification does not insure against market loss. For illustrative purposes only. There is no assurance that the investment strategies and processes mentioned herein will be effective under all market conditions. Investors should evaluate their ability to invest for a long-term based on their individual risk profile, especially during periods of downturn in the market. Past performance is not indicative of future results.
How are you positioned in the Asia IG market?
\nSlim: Our positioning reflects our expectation of more return dispersion in the next few quarters. This is reflective of a few investment themes dominating the Asia credit market, the most important of which is an evolving Chinese policy environment. China is the largest component of the Asia credit market and is expected to continue to grow in market share. As such, Chinese developments have wide-ranging ramifications for the overall market. In 2021, Chinese policy makers clearly signaled that sovereign support will be, at the very least, less forthcoming and any policy support will be highly targeted. This is a theme that we think is not fully priced in yet. It drives our more cautious positioning within the Chinese space, consistent with our investment process that simultaneously analyzes fundamentals, valuations, and technical factors. Our positioning also integrates our environmental, social and governance (ESG) views, which are an essential part of our selection process.
What potential risks are on your radar?
\nSlim: There are three risks that we are focusing on. First, Chinese investing is undoubtedly going through a paradigm shift and policy risk is inherently higher during that phase. We have reasons to believe that policy makers will continue to be able to fine-tune policy without creating systemic risk. Therefore, our base case scenario is that volatility, when it occurs, tends to be localized in one segment of the market. Second, the pandemic continues to dominate headlines but there’s growing divergence in how Asian countries are approaching it. For instance, China and Hong Kong continue to pursue a “Zero Covid” policy while Singapore is trying to “live with the virus.” This has economic and investment repercussions. Third, regional and geopolitical risks are elevated; although for now, they continue to be a tail risk.
After the credit scares last year, particularly in the high yield segment, what is the outlook for default risk in 2022?
\nLau: We expect the overall default rate in Asia to fall in 2022, primarily because of lower expected defaults in the Chinese property sector. Nonetheless, we think selective sovereign and Chinese property developers that face continued financing and liquidity pressure may have to restructure or default in 2022. As such, default risk in select sectors may remain high, albeit in an improving trend.
Meanwhile, a benign economic outlook should continue to provide a constructive backdrop for corporates. Among IG corporates, the credit matrix in general continues to improve. We currently expect less than 1% fallen angel risk in the Asia IG investible universe under our coverage.
How do you navigate across Asia’s trillion-dollar bond market? What should investors bear in mind?
\nLau: There is no substitute for thorough credit research and credit selection. Our investment thesis favors greater issuer differentiation to find value opportunities in Asia bonds. At the core of PineBridge’s global fixed income organization is a team of credit analysts who are highly experienced in different sectors and markets. This deep sector knowledge is combined with on-the-ground insights to help us create a complete credit picture of the potential returns as well as risks. Having the agility to reposition our portfolio according to market conditions is also important, and may be harder to achieve through index tracking. Over the long run, the ability to navigate Asia’s changing economic, regulatory, and geopolitical landscape will also play a key role in investing successfully in this asset class.
1 JPMorgan, 30 September 2021.
2 BAML, PineBridge Investments as of 30 June 2021.
3 Duration measures how much bond prices are likely to change when interest rates change. It is a gauge of interest rate risk and is expressed in years. The shorter the duration, the less sensitive a bond’s price is to interest rate changes.
4 Sharpe ratio is the most common measure for calculating risk-adjusted return for a fund. The Sharpe ratio is the average return earned in excess of the risk-free rate per unit of risk (volatility). The higher the Sharpe ratio, the better the returns compared to the risk taken.
Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"High Quality Asia Bonds Offer Stability and Yield Amid Fixed Income Flux","custom_s_image":"/_assets/images/articles/article-cover-images/2021/03-asian-investment-grade-bonds-offer-stability-and-yield_march-2021.jpg","custom_ss_authors":["80377","80511"],"custom_ss_author_links":["/bio/lau-arthur-cfa","/bio/slim-omar-cfa"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"High quality Asia bonds have been insulated from recent credit scares and continue to offer attractive yields, making them compelling diversifiers in global portfolios. ","custom_s_local_url":"/en/investor-types/default/insights/high-quality-asia-bonds-offer-stability-and-yield-amid-fixed-income-flux","score":1.0},{"id":"178069","custom_i_asset_id":178069,"custom_s_title":"2022 Insurance Investment Outlook: Embracing Greater Complexity","custom_dt_date":"2021-11-15T00:00:00Z","custom_s_description":"The insurance industry is embracing greater complexity amid low asset yields, uncertain economic conditions, and evolving trends such as manager/insurer tie-ups and impact investing. The desire to diversify sources of income and enhance yields through nontraditional assets has led to increased consolidation and a proliferation of private equity (PE) and other asset management firms acquiring or partnering with insurers. Insurers and other asset owners are also watching the evolving regulatory landscape and heightened focus globally on ESG issues. These key trends are expected to continue into 2022 amid a very dynamic economic, regulatory, and geopolitical environment.
\nTo combat concerns about rising inflation, higher interest rates, and pandemic/policy-related shocks, insurers are adding real assets, floating-rate products, and semi-liquid strategies. Within real assets, real estate investments backed by suburban offices and industrial/logistic properties have performed well recently, reflecting the dramatically changing demand from businesses and consumers due to the pandemic. Insurers are finding that floating-rate assets such as direct lending, commercial mortgage loans (CMLs), and collateralized loan obligations (CLOs) are well positioned in a rising rate environment. Alternatives are also popular given their potential for higher and uncorrelated returns. Semi-liquid products that invest in a mixture of liquid public securities and private assets may also help insurers meet both yield and liquidity needs in volatile times.
\nTight asset yields are driving insurers to diversify income sources via strategic partnerships or mergers and acquisitions (M&A) between insurers and investment managers. These partnerships can come in several forms. Many PE firms have pursued partnerships via partial or full ownership of insurance companies, particularly annuity writers. For PE managers, the attraction is the long-term stable capital that comes with affiliated insurance assets. According to the Capital Markets Bureau of the National Association of Insurance Commissioners (NAIC), 177 US insurers were owned or controlled by private equity firms with total cash and invested assets of approximately $487 billion in 2020. That was up by about 200% from 89 insurers and 42% from $344 billion in 2019.1 The proliferation of the PE activity has caught the NAIC’s attention regarding its potential impact on the industry.
\nInsurers are often drawn to asset managers to supplement their in-house investment capabilities. Asset managers can offer value-added expertise in managing and originating nontraditional assets with attractive illiquidity premiums (direct lending, real estate, and alternatives), better geographical diversification (emerging market securities), and greater complexity premiums (structured securities). In addition, managers with deep roots in insurance asset management can help structure insurance-friendly solutions to maximize capital-adjusted returns within insurers’ asset liability management (ALM) constraints. And capital management is increasingly complex, as many insurers must model and optimize across multiple capital regimes, including statutory, AM Best, S&P, and others.
\nThe NAIC is also reviewing its definition of a bond, in part due to complexities related to securities with equity-like characteristics being filed as bonds. The NAIC has indicated that changes related to bond definitions likely won’t go into effect until January 2024 at the earliest. Separately, the NAIC is looking into private letter ratings and their rating accuracy.2 These changes may affect a security’s eligibility for filing exemption designation, the use of credit ratings, and the statutory capital charges. To further complicate things, it’s quite possible that certain investments will not be grandfathered, or that a transition framework may be created.
\nGoing forward, capital efficiency will become more important than ever. This year’s newly approved bond factors are expected to increase statutory risk-based capital requirements for life, property and casualty (PC), and health insurers broadly starting in 2022.3 That may lead insurers to increasingly rely on asset managers that can offer capital-friendly solutions and expertise in efficient funding sources such as Federal Home Loan Bank (FHLB) lending.
\nClimate change has long been central to PC (re)insurers due to their underwriting exposure to natural catastrophes (e.g., hurricanes and wildfires) and social risks (e.g., the US opioid epidemic). But besides that, as asset owners, insurers are increasingly integrating holistic ESG considerations into their investment decisions and regulatory disclosures, and they’re joining the growing ranks of investors who are requiring their asset managers to report portfolio data related to carbon emissions.
\nRegulators have been gradually requesting more ESG reporting and testing, and we expect that trend to continue. For example, the UK Prudential Regulation Authority has requested UK insurers to stress-test investment portfolios for climate risk. In 2021, the UK central bank issued a Climate Biennial Exploratory Scenario (CBES) survey to analyze the climate risk of financial exposures, covering both assets and liabilities, of the country’s largest banks and insurers.4
\nIn the US, ESG disclosures and testing vary by state. For example, New York and California have been particularly active in this area. NY has issued proposed guidance for its insurers regarding governance structure, financial risks, scenario analysis, and disclosures related to climate change.5 6 To help track insurance climate risk exposures, the NAIC adopted an Insurer Climate Risk Disclosure Survey in 2010 and a Taskforce on Climate-Related Financial Disclosures (TCFD) report in 2017.7 8
\nLooking ahead to 2022, PineBridge expects insurers to continue diligently expanding into new and more diversified sources of income and return, and to pursue these strategies in structures that best fit their ALM and regulatory needs. Insurers are increasingly subject to greater ESG reporting requirements. Finding the right strategies, structures, and investment partners that cover all these fronts will remain essential to competing in this increasingly complex marketplace.
\nFor more economic and asset class insights, see our full 2022 Investment Outlook: Opportunities in a Climate of Change.
\n1 Source: NAIC Capital Markets Special Report as of year-end 2020.
2 Source: PineBridge Investments, “Investment Implications of NAIC Revisions to SSAP No. 43R and Bespoke Securities,” October 2020.
3 Source: PineBridge Investments, “What New Risk-Based Capital Bond Factors Could Mean for Life Insurers, June 2021.
4 Source: https://www.bankofengland.co.uk/stress-testing/2021/key-elements-2021-biennial-exploratory-scenario-financial-risks-climate-change, June 2021.
5 Source: Proposed Guidance for NY Domestic Insurers on Managing the Financial Risks from Climate Change, March 2021.
6 Source: NYSDFS: An Analysis of New York Domestic Insurers’ Exposure to Transition Risks and Opportunities from Climate Change, June 2021.
7 Source: Assessment of and Insights from NAIC Climate Risk and Disclosure Data, November 2020.
8 Source: Task Force on Climate-related Financial Disclosures, October 2020.
Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"2022 Insurance Investment Outlook: Embracing Greater Complexity","custom_s_image":"/_assets/images/articles/article-cover-images/2021/2022outlook_insurance.jpg","custom_ss_authors":["150086","80347","178715"],"custom_ss_author_links":["/bio/remeza-helen","/bio/heal-jeannine-cfa","/bio/mccormack-james"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"Insurers are exploring more complex sources of income to address the challenges across markets, from low yields to inflation and interest rate uncertainty. Helen Remeza, Jeannine Heal, and James McCormack of PineBridge Insurance Solutions discuss these developments and what’s ahead for insurance investing.","custom_s_local_url":"/en/investor-types/default/insights/2022-insurance-outlook","score":1.0},{"id":"178084","custom_i_asset_id":178084,"custom_s_title":"2022 Fixed Income Outlook: Transitioning Toward the ‘Next Normal’","custom_dt_date":"2021-11-15T00:00:00Z","custom_s_description":"Fixed income investors continue to balance the shifting tailwinds from supportive macro fundamentals and improving corporate earnings potential with prospects for slowing growth, higher inflation, and less accommodative monetary policy as we head into 2022.
\nRobust demand for yield and hence credit has resulted in the easy absorption of a record supply of new issuance. Yet the late-cycle valuations are well supported by plunging default rates and improved underlying leverage metrics. As we transition toward a post-Covid world and the distortions arising from it, 2022 represents the path to normalization with respect to fiscal and monetary policies, economic trends, and, across society, the “Next Normal.”
\nSince the global financial crisis (GFC), central bank monetary policy has arguably been the dominant influence on global financial markets, and 2022 represents a potential transition in policy toward the Next Normal equilibrium. The Federal Reserve has commenced its taper of purchases and issued guidance toward a steady pace of $15 billion per month before exiting in June 2022. Other central banks are also seeking to exit extraordinary measures enacted during the Covid crisis, but their pace and approach will differ. What is less certain with respect to the Fed is the timing and pace of policy rate increases, with the market pricing in two hikes in 2022, and even more surprisingly, pricing in a hike by the European Central Bank (ECB) as well. Surging inflation has reignited the debate on (and definitions of) transitory and secular increases. On the flip side, China’s policy pivot and the shift away from globalization are indications of slowing global growth.
\nWhile yield curves have lifted from a secular bottom, the magnitude of any future upturns will not be materially higher; we expect interest rates to remain persistently low in the Next Normal, with a continuation of negative real policy rates. In this environment, investors will continue to reach for yield but under broadly accommodative market conditions.
\nAgainst this backdrop, for 2022, we remain most constructive on leveraged finance assets, including bank loans and high yield bonds, as well as small and medium enterprise (SME) private credit. Collateralized loan obligations (CLOs), and the incremental complexity yield premium they bring, are also highly attractive in a near-zero default environment. Despite China’s property sector woes, we believe emerging markets (EM) continue to offer attractive opportunities and that investors may benefit from a selective approach as quality names get caught up in negative headlines.
\nWe’re also constructive on investment grade credit, with attractive all-in yields, net leverage now below pre-Covid levels, and upgrades expected to far outpace downgrades in 2022. But with expectations for short-term periods of volatility during the transition, we believe it’s prudent to have some dry powder on hand in the form of high-quality short-duration securities to act during periods of weakness.
\nInflation expectations are still front and center for investors amid price surges that will persist longer than many expected, raising concerns about the impact on fixed income asset classes. Despite these worries, we continue to believe that sustained higher inflation is highly unlikely in the Next Normal and that much of the price increases we’re experiencing are still primarily attributable to reemerging demand and supply chain bottlenecks that will ultimately resolve toward the end of 2022. However, the stair-step in a large portion of the current rise will not reverse and may reset at the higher levels – this means inflation could be marginally higher relative to prior trends due to several longer-lasting factors.
\nMuch of the demand tailwind arising from government stimulus will wane, given that these efforts have been primarily focused on one-time income replacement and demand generation. And while additional stimulus measures, such as infrastructure spending in the US, are in the offing, we believe their impact on sustainable inflation will be limited. That said, we do expect a more permanent policy shift in favor of fiscal stimulus and a greater willingness from governments globally to run budget deficits, particularly given the low cost of funding and populist support.
\nLooking over the longer term, the question becomes, what structural factors have led, pre-pandemic, to the ongoing secular decline in inflation, and will they change? When we consider what has caused inflation to remain low over the past several decades, it boils down to three primary drivers: 1) demographic trends, including an aging population and declining birth rates, particularly in the developed markets; 2) the impact of technological advancements; and 3) a global savings glut.
\nLooking out over the next decade, we expect these core trends to persist. So what is different? We see three factors that will incrementally push inflation higher: 1) lower and negative real policy rates; 2) the aforementioned greater fiscal stimulus, particularly focused on social equity; and 3) the adoption and implementation of environmental, social, and governance (ESG) improvement initiatives.
\nWhile we expect to see a somewhat higher level of inflation in the Next Normal after transitory factors fade toward the end of 2022, inflation will not be persistently high as we reset toward pre-Covid trend-plus levels.
\nWhat are the implications of these developments for yield curves and government bonds? In the short term, we expect yields to remain range-bound, with a skew toward higher yields at the back end of the curve – but only marginally, given the Fed’s tapering path and its march toward normalized policy rates anchored at very low levels. The front end is already pricing in a much more aggressive stance for 2022, and we believe a more dovish outcome will be the result.
\nOver the intermediate to longer term, the question becomes what the Next Normal’s “normalized” yield curve will look like, which begins by setting our expectation for a “neutral” policy rate. We believe that in the US, the Fed will ultimately reach a neutral policy rate in the low 1% area, and the resulting impact will be negative real policy rates for the foreseeable future. This is in contrast to the Fed’s dot-plot forecasts, which indicate a 2.5% rate. Similarly, the ECB has been mired in negative interest rates for a while, and we don't expect policy rates to breach zero for some time; but ultimately, a neutral rate goal will be to achieve positive nominal rates.
\nWith a positively sloped yield curve overall but lower term premiums relative to historical levels, and with the policy rate setting the short end of the curve, we expect a fairly low (1.5%-2.0%) range at the 10-year end of the curve for US Treasuries – much lower than historical levels, but somewhat higher than what we’ve seen during the crisis period of the past 18 months. While there is concern that US interest rates could rise substantially above that range, we think it’s important to remember that global rates are highly interconnected: US Treasuries cannot persistently rise materially above German bunds or other key rates on a foreign exchange (FX) hedged basis. That dynamic will limit and anchor US Treasury rates despite stronger growth expectations relative to many other developed nations.
\nAs discussed in our 2021 midyear outlook, fundamentals are still showing largely early-cycle characteristics in the rebound following the Covid-prompted short-but-sharp recession and spike in defaults during 2020 towards a near-zero default environment in 2021 and remaining ultra-low in 2022. Credit mini-cycles are becoming more frequent, within elongated credit default cycles. While we’re now heading toward mid-cycle in 2022, we expect continued tailwinds and solid growth in corporate earnings, but at a slowing pace and with wider dispersion as cost pressures filter into margin compression for certain segments.
\nOverall, these conditions are supportive of credit spreads for the foreseeable future, but current late-cycle valuations have minimal room for price appreciation, capping return potential to coupon yields. One of the few areas where we see outsized return opportunities (amid high risks) is within Asia corporate credit, and particularly within the Chinese property segment. Fear and dislocation have historically been the source of the best investment opportunities for those who can effectively filter through the trauma.
\nYet one factor that we believe must be taken into account is that historical risk premia for all assets are in need of a readjustment given central bank supported market conditions over the next five to ten years. In addition to the negative real policy rate environment, central banks, and the Fed in particular, have shown their willingness to forcefully jump into financial markets at the first sign of an exogenous shock or recessionary environment – which essentially truncates the most severe, left-tail risks.
\nTaken together, these factors indicate that historical risk premia for risk assets more broadly are no longer appropriate, and that current tight valuations are not necessarily overvaluations – rather, they fall within the range of fair value when adjusted to reflect Next Normal risk premia.
\nGiven our view that early- to mid-cycle fundamentals still predominate, investors are operating in an environment of excess yield return opportunities supported by low default rates and improving corporate earnings trends. While potential fallout from China’s evolving property sector has thrown a wrench into default forecasts for China and for emerging markets more broadly, we have noted minimal contagion thus far in the broader EM indices and attractive opportunities emerging amidst the rubble.
\nAgainst this backdrop, we favor taking on additional credit risk exposure relative to government bonds, particularly leveraged finance credit in the form of bank loans as well their hybrid, CLOs, along with high yield bonds. Investors also are turning to private debt markets, which offer incremental yield from illiquidity and small-company premiums.
\nAmid a broadly improving global outlook, we see attractive valuation opportunities in targeted geographic risk premia in emerging markets. We are more constructive generally on corporate credit in EM, with supportive fundamentals, but see pockets of opportunities in local currency. But the big question in EM, of course, is the impact of developments in China, including the ongoing property segment saga and the country’s recent policy pivot.
\nThus far China’s credit market volatility has not shown evidence of widespread contagion in EM, although default forecasts are rising for weaker participants in property and related sectors as external liquidity access evaporates. We believe these and other corporate credit stories are idiosyncratic in nature and do not yet pose systemic risks. If headline events lead to more broad-based spread widening, this may create opportunities to invest in companies caught up in the risk-off sentiment.
\nWe expect the evaluation of ESG risks, while critical across fixed income, to take on an increasingly important role in identifying EM securities that will outperform in a market where traditional credit risk appears fairly valued. As noted in a recent blog post, we believe comprehensive integration of ESG into investment research can add alpha by seeking out issuers who are actively committed to improving their operations’ sustainability and, therefore, their ESG risk ratings.
\n![\"ESG](\"/_assets/images/articles/charts/outlook/emd-blog-outlook-nov-2021-2.gif\")
Source: JP Morgan, MSCI and PineBridge Investments as of 20 October 2021. Excludes China property sector and securities with idiosyncratic performance greater than 20% or less than -20% for the year. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
Amid continued broadly low return expectations and the quick shifts in fixed income markets of late, we believe it's critical to look within asset classes that offer compelling alpha potential and to capture those opportunities when they present themselves. This means taking a flexible, opportunistic approach to incrementally capture relative value, not only across asset classes and geographies, but also with specific securities.
\nWhile lower return expectations create a challenging environment heading into 2022, it is also a lower-risk environment for many areas of fixed income. The key will be identifying and pricing those risks, and managing them consistently to produce favorable investment outcomes.
\nFor more economic and asset class insights, see our full 2022 Investment Outlook: Opportunities in a Climate of Change.
\nInvesting involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"2022 Fixed Income Outlook: Finding (and Pricing) the Right Risks","custom_s_image":"/_assets/images/articles/article-cover-images/2021/2022outlook_fi.jpg","custom_ss_authors":["80188"],"custom_ss_author_links":["/bio/oh-steven"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"","custom_s_local_url":"/en/investor-types/default/insights/2022-fixed-income-outlook","score":1.0},{"id":"177588","custom_i_asset_id":177588,"custom_s_title":"2022 Asia Fixed Income Outlook: Holding Steady Amid Policy Shifts","custom_dt_date":"2021-11-15T00:00:00Z","custom_s_description":"Asia’s credit fundamentals are steady and improving outside of a few sectors and idiosyncratic situations, which should offer a strong foundation for the region’s fixed income market in a potentially choppy, policy-driven 2022.
![\"Comparison](\"/_assets/images/articles/charts/outlook/2022asiafioutlook_chart01.gif\")
![\"Comparison](\"/_assets/images/articles/charts/outlook/2022asiafioutlook_chart02.gif\")
Source: Data as of 30 June 2021. BAML. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
We expect credit spreads to tighten in the next 12 months, with pronounced credit divergency alongside the expected increase in the number of defaults in 2021. The default rate is likely to rise to the low teens in full year 2021. However, we expect this to fall to single-digits in 2022. We view these defaults to be mainly idiosyncratic rather than systemic in nature, which calls for thorough credit differentiation.
\nUncertainty from China’s policy reforms will be the major near-term source of volatility in the investment markets, while the impact from Covid-19 should ease more noticeably. Chinese policy reforms may be difficult to predict and this unpredictability may make it challenging to assess investment risk. The changes may also hurt the real economy, which is already showing signs of deceleration. We believe volatility will remains higher than the historical average for some time, although we expect it to subside gradually in next 12 months.
\nWith Chinese high yield (HY) bonds accounting for over 50% of Asia’s HY bond market, the development of this segment will determine how the broader market will perform over the next 12 months. In the near term, we expect the Chinese property sector to remain under pressure as concerns about the sector’s liquidity and refinancing risks intensify, but we believe the government has adequate tools to contain any risk from this sector. That said, investors should put Chinese property developers that face significant near-term liquidity or refinancing pressures in a different bracket than other issuers.
\nAn economic slowdown and ongoing policy reforms may pose risks while also creating opportunities, as potential policy easing and supportive measures may reverse the current defensive sentiment. At the same time, policy reforms will likely benefit sectors whose activities are aligned with the central government’s agenda.
\nOutside China, we are constructive on the commodity sector given the hefty credit buffer these companies have built in recent years from the surge in commodity prices. The credit matrix should have adequate cushion to absorb any slowdown in economic growth. Compared to the Chinese property sector, we think Asian commodities will be a more stable, lower-beta sector.
\nIn contrast to the first half of 2021, we think the volatility in Asia’s investment grade (IG) market will ease in the coming 12 months given the overall benign economic backdrop. While we think current credit spreads look reasonable based on credit fundamentals and compared with historical averages, US interest rates will likely be the major source of risk. We think a duration-neutral strategy against benchmarks may be more effective to avoid excessive volatility.
\nWe believe investors should also stay away from crossover issuers to avoid the risk of a potential rating downgrade that could pull the bond into HY territory. We think with a more uncertain growth outlook and interest rate risk, an IG portfolio with higher overall credit quality should generate better risk-adjusted returns.
\nThe surge in ESG-linked bonds in Asia in 2021 has underscored the market’s demand for companies with strong performance on environmental, social, and governance measures. Over the last 12 months, premiums in pricing between strong- versus poor- performing companies on ESG have become more and more discernible.
![\"2021:](\"/_assets/images/articles/charts/outlook/2022asiafioutlook_chart03.gif\")
Source: JPMorgan as of 30 September 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
ESG-related sectors like renewables are gathering more and more technical support from US and European investors, which is partly driving higher pricing given tighter comps in developed markets. In previous years, Asia represented around 50% of renewable deals; today, Asia, Europe, and the US have roughly the same share.
\nFor companies performing poorly on ESG, the window for raising capital in the offshore US dollar market appears to be narrowing as the investor base shrinks, potentially pushing issuers toward more serious ESG commitments in return for capital. Refinancing risks will be higher going forward for credits with large bullet maturities (such as Indonesian coal mining companies and Australian coal terminals) and will need to be monitored closely. Issuers with amortizing bond structures (such as Indonesian coal independent power producers) will be better placed from a refinancing risk perspective.
\nSustainability-linked bonds (SLBs) have been a new development to the Asian market in 2021 and are likely to become more commonplace going forward. These are often issuers with below-average ESG characteristics that have set out sustainability targets, which, if not met, could result in a coupon step-up at a specific year (usually close to the final year). While they sound good on paper, most of the issuers of these bonds thus far have either unambitious targets or negligible, non-punitive coupon step provisions, in our view, which offer limited additional incentive for them to work toward achieving those targets. We believe greater scrutiny from the investor community will be needed to make the targets/compensation more meaningful.
\nThe stable outlook for the Asia bond market could face potential headwinds from rising inflationary pressure in the West, the slowdown in China, and any return to widespread Covid-19 lockdowns. While we still view current inflationary risk as transitory, the longer the disruption in global production chains persists, the higher the risk that inflation becomes cyclical, if not structural. While we currently do not expect this outcome, we think the risk is growing. With this is mind, we are mindful of potential interest rate shocks should inflationary forces become more entrenched.
\nMeanwhile. the surge in oil prices coupled with a slowdown in China may be a double whammy for some Asian countries, which may end up importing inflation into their domestic economies while facing a reduction in exports to China.
\nCovid-19, while becoming less of a market disrupter as vaccinations progress across the region, may still have the potential to roil markets should more infectious and vaccine-resistant variants emerge and force new lockdowns.
\nOverall, the uneven recovery that we have seen in 2021 is likely to continue as inflationary forces play out differently across the global economy, complicating the timelines toward rate normalization as well as the momentum of corporate recovery. Flexibility and credit selection will remain the watchwords for 2022.
\nInvesting involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
\n\n
Following COP26, it’s clear that the road to 2050 is long and that emerging markets are essential for reaching net-zero.
\nImane Kabbaj
\nWelcome to the PineBridge Investments podcast. My name is Imane Kabbaj and I'm the Sustainable Investment Specialist here at PineBridge. I am joined today by John Bates, our Head of EM Corporate Research. Today's topic is one that's been monopolizing the media headlines for the past few weeks and we're talking here about COP26, which I had the immense privilege to attend last week.
\nToday, we'll be looking at the five key areas that caught everyone's attention after the first week of COP26. So the first key thing that we will be talking about is at the country level and the country representation. So here we'll be looking at two elements. The first one is the attendance or the absence of the most important key players in the fight against climate change. And the second aspect is about the NDCs, the nationally determined contributions.
\nSo first of all, it was very hard actually, not to notice the absence of some key international players, not only from a G 20 perspective, but then also from the CO2 emissions perspective. So we're talking here, about countries such as China, Russia, Brazil, Mexico, and South Africa, who although have sent their own delegations, their presidents did not attend for various reasons. So these countries are some of the biggest CO2 emitters in the world. And we can argue, undeniably that they are vital in the success of the fight against climate change.
\nThe second aspects of this first observation is the NDCs. So COP26, was the occasion for most of the countries to either update their NDCs contributions, or in fact, just publish them. And we've noticed quite a big discrepancy between those NDCs. So you have some very ambitious ones. And then we have also some others that haven't really quite lived up to expectations.
\nAnd in this second front, it's mainly around some of the EM countries, but I would also argue DM as well. So some specific examples. we have Australia, a G20 country as well, that have committed a pledge to reach Net Zero by 2050. But at the same time also, it did not make any sort of concrete plan to exit coal, or how are they going to be dealing with coal considering coal is one of the most polluting energy sources. And then Australia is the biggest producer of coal in the world.
\nWe also have India, which is one of the highly polluting countries in the world and represents a big proportion of the CO2 emissions, that have made a pledge to reach NetZero, but by 2070, which is 20 years off the global benchmark that we're using here, which is 2050.
\nAnd then you have China and Saudi Arabia that have both pledged to reach NetZero emissions by 2060. And then again, this is a little bit off the mark. And there was some praise, but then also scepticism about how these pledges are going to be reached. And this actually, all of these discrepancies in numbers, and the absence of certain presidents, despite sending some delegations actually begs the question, John, what signal are those countries and into the world? And is it really possible to achieve Net Zero without the participation and the involvement of these big international players?
\nJohn Bates
\nThanks to you Imane, and it's great to have you back from COP26. You were there yesterday, it seems like a lifetime ago, so much seems to be happening in this area. But I would just start by saying that emerging markets are absolutely essential for reaching Net Zero. I know it's a cliché, but we really are all in this together. And actually, I'm not surprised there's been so much focus on these certain countries and China, Russia, Brazil not being present, as they are generally not viewed very positively in ESG terms, especially by the Western media.
\nFirstly, I think this is quite unfounded and rather unreasonable. These countries are not solely responsible for global warming, all have very different reasons for the current status, in terms of getting to Net Zero. And it's one of these areas where it's very easy to judge them or criticize, but it's very clear that the planet is going to need a sustained effort from all of the world's largest polluters.
\nEverybody needs to make their commitment, not just a pledge and most of us will encounter some kind of conflict when we go through this journey. For example, Saudi Arabia and its reliance on oil, Australia and its reliance on the abundance of coal that it has there.
\nJust to put things into perspective, though, the USA produces 12.9 tonnes of CO2 per annum on a per capita basis. The world as a whole produces 4.4 tonnes per capita. You mentioned India Imane, well, that produces 1.7 tonnes per capita, so much, much lower.
\nObviously, there are reasons for this, macro economic, political, demographic reasons for this. But we think that Net Zero and that the journey to Net Zero represents really one of the biggest opportunities of a lifetime in terms of investment. And the investment is going to be staggering. And it will really change the face of some of these emerging markets and narrow the imbalances between EM and DM.
\nAnd I liken this a little bit to what happened on a much smaller scale in mobile telephony. We saw mobile phones growing in the West. And then, you know, places like Africa, they were able to install mobile networks where they didn't even have fixed line networks, but for literally a fraction of the cost, because all of that technology had already been paid for by Western countries.
\nSo also, it's not about just getting newer energy, newer, greener energy, but also about using less energy. So the big consumers are largely actually in developed markets, as well as some of the larger emerging market countries. Looking at a couple of the other bigger EMs that you mentioned, Imane, which are drawing some of the bad press -if you look at Russia, Russia today, actually produces almost half of the carbon emitted back in the days of the Soviet Union.
\nOf course, to get to this, the country had to endure revolutions, economic chaos, but the economic growth prior to the breakdown of the USSR, was fuelled by heavy industry-led investment in infrastructure, much of which is now totally obsolete. In this sense, Russia is actually much further down the line and in a much stronger position, having already been through a chaotic and transformative change of fortune.
\nSo this has actually got parallels with what's going on in China at the moment. The developed world should not get into the mistake of viewing China as the single biggest problem to the journey to Net Zero. But it's also not the biggest solution to climate change. Even though China accounts for nearly one third of the world's emissions. Our Hong Kong investment team, who are right in the eye of the storm of the current China property crisis, are confident that the policy changes and reform that's going on in China will have very positive results over the long term.
\nWe will certainly generate a lot of negative reaction in the short medium term, both in terms of sentiment and as well as capital market flows. But China is trying to move away from its debt fuelled construction model towards a more sustainable consumer driven prosperity system and the scale of change needed is massive, as the country needs to wean itself away from the emissions heavy, construction investment growth model, which has driven economic growth over the past decade.
\nSo we think the authorities are waking up in China, they are taking aim at the existing growth model. And I think we'll see defaults in some of the larger entities in property. And the knock on effect of this will be a transformative change in the funding model for that sector. And at the end of the day, if countries don't behave themselves, they're going to lose out on funding opportunities and decent funding levels and terms. And I think that's what's really going to change as we head down the road towards NetZero.
\nSo Imane, I know that you, you attended some many of the conversations. And I think deforestation was one of the issues that you came across as well. What's the scoop on that?
\nImane Kabbaj
\nYou have actually been raising some very interesting points. So the first one, the fact that you are saying that there is an unfair criticism towards EM countries, and their pledges towards Net Zero and how they are attaining that, I think we can almost talk about some sort of an EM bias and an ESG bias.
\nAnd then the fact that some EM countries are actually falling short in terms of their narratives, their ESG narratives at least. And you really mentioned quite a lot about efforts from EM countries in regards to energy and how they're dealing with that, and all the investments that are happening in energy.
\nSo energy was definitely a theme that was on the agenda last week for COP26 and it is definitely one of the key themes that has been recurrent. So if we look at one of the reports, by the IEA, the International Energy Agency, a report that they published just before COP26.
\nSo it said that like 70% of the GHG Emissions are actually energy related. And that energy transition is therefore one of the keys to succeeding in reaching Net Zero. That same report by The International Energy Agency is also showing a huge gap in energy transition from them. So you were talking about EM countries and how they are making efforts, but then that probably is still not living up to the expectations. And there is a huge gap between what is the current level of investment and then what is definitely needed to reach NetZero. And then perhaps this gap is a little bit bigger in Emerging Market countries. And this is why perhaps they're suffering from this unfair criticism or this EM bias, as we would like to call it.
\nSo according to that report, in order to be able to reach Net Zero, the investment in clear energy needs to be over $1 trillion on a yearly basis between now and 2050 so o that can we really attain net zero? And if we look at this from an EM perspective, what parts could those EM countries play in this energy transition? And what can be done to bridge this funding gap?
\nJohn Bates
\nWell, that's a great question. And I think, you know, the answer really lies in the ability of these emerging market nations to find funding sources. And these are going to come from several areas.
\nSo the first area is from the local systems, the corporates themselves, that we'll be raising finance from the international markets from project led financing. And also, you know, the whole idea about getting to NetZero is definitely swayed towards energy. I think from what I have read, over approximately 70% of the road to Net Zero will be financed into the energy sector.
\nWhile many developed markets pretend to be ahead of the game, wealthier countries tend to just have a slightly different set of issues to emerging markets with the cost of getting to NetZero and there are some nuances between the two.
\nThe evolution of new clean energy infrastructure will be a lot more cost effective in Emerging markets in 10 years from now, and building new will have many advantages over replacing old infrastructure, which is actually an issue that the EM will benefit from, pertaining to EM versus DM.
\nThe United Nations Framework Convention on Climate Change came up with an estimate of a massive 125 trillion in total investment in decarbonisation through until 2050. And that equates to about 32 trillion in this decade, so that is up till 2030. That basically means a tripling of direct capital investment over the next four years, compared to the last four years, and would need to average 4.5 trillion per year after 2026.
\nSo for EM, as I say, it's going to be private versus public financing. Corporates are typically the main investors in decarbonisation projects, supported by banks, and government led programs.
\nIn terms of regions, Asia Pacific region is by far the biggest in terms of need for decarbonisation investment. They will require about $14 trillion between now and 2030. But the US and EU, to put that in perspective combined, will also require 12.5. So the EU and the US will be almost equivalent to the Asia Pacific region.
\nSo it's a global phenomenon in terms of funding the road to to NetZero. It's not an EM issue, it is a global issue and it clearly represents this amazing opportunity for investors. Investors could be in the pool of providing up to 70% of this investment. And again, it's going to be more than just energy as well because obviously there's buildings, the transport industry, low emission fuels, and everything else that's involved.
\nImane Kabbaj
\nThank you, John. So you've pointed out that there is a very big opportunity in funding the energy transition and the needs there are huge and this area looks very much to be capital starved. And talking about energy's transition and it's making it successful, it is actually very hard also not to look at the other challenges, which is mainly called, it's very difficult to talk about energy transitions, COP26, the race to Net Zero without talking about coal.
\nAnd coal has been a very big agenda item here at COP26. So before the start of the event, the goal and the objective of this COP26 was initially and I am quoting, “to consign call to history”.
\nAnd now we have one week to go before the end of the event, and we're not exactly close to this goal. So there are some interesting and encouraging signs that are happening towards this. We can talk, of course about the pledge that has been signed by more than 40 countries to shift away from coal. And this is what is going to help the overall decarbonisation.
\nWe can also mention the 8.5 billion pounds pledge that South Africa is to receive to help energy transition away from coal. We are yet to witness a larger scheme of coal divestment at the global level. And one of the main reasons for that is we can look at all the main coal consumers, and then also the coal producer countries that have not signed up to this pledge. And so what John, do you think, in your opinion, could be done to help the transition away from coal? And how can we link it to the overall energy transition that we've spoken about earlier?
\nJohn Bates
\nThanks Imane and yes, coal is a real, real problem. If you look at the top five, if you like the league table for international coal reliance, it's led by China, followed by India, followed by the US, then Australia, and then Indonesia. I mean, there are several initiatives underway. But obviously, some of these countries, like the US and China are hugely reliant on coal and also it employs thousands and thousands of people in the coal industry, and the relative food supply chains that feed off from that.
\nSo the failure of the US and China to sign up to a deal to phase out coal production puts pressure on the whole world, and its ability to tackle coal related emissions. I think, in EM as well, India is the world's second largest producer, and consumer of coal after China, and polluting fuels accounted for 70% of its power generation. So it's absolutely embedded in the economy of India as an example.
\nSo it's very difficult for them to set zero emission targets without taking into consideration the economic damage that will be done to the country for totally phasing out coal. So while the Prime Minister has set some ambitious targets, they have committed to building 450 Gigawatts of solar and other renewable power by 2030, this would actually only bring the share of coal to around half of the power generation needed, and the quantity of coal usage will actually increase.
\nAgain, though, it's easy to point the finger at countries like India, which has widespread poverty, with millions surviving with very little power supply. And per capita consumption, as I mentioned before, is actually running at around one third of the global average, so they are actually consuming a lot less than the rest of the planet.
\nIt's true that coal is vital. The question for investors is how much commitment can countries like India commit to, before they start to lose appeal as a sustainable investment destination? So again, you know, with my investors hat on, you know, if they really cannot increase their renewable energy and reduce their reliance on coal, they will become a less attractive investment destination, and the capital flows will go elsewhere. And, you know, that's where the government really needs to tidy up its policies, work with other countries and come up with a really strong, sustainable plan.
\nBut again, this is a massive opportunity. Consumption is really low. They're coming from a very low base level and I think you know, it's not as if the Indian economy is short of expertise and the sort of people who can get the job done. I just think this is a very exciting time for these types of countries.
\nImane Kabbaj
\nSo John, you actually mentioned about the opportunity there, in regards to the divestments from coal, coal being one of the most polluting industries and actually one of the most polluted energy sources that there is at the moment. If we talk about other big polluters, it is very difficult not to mention methane as well, which was another key highlight, and another discussion theme at COP26. So as we know, methane is a GHG, which is “greenhouse gas”. It has more than 80 times the warming power of CO2, so obviously more polluting, but it dissolves in the atmosphere a lot quicker. So we're talking about 15-20 years on average for methane, in comparison with an average 50 years for co2.
\nSo cutting the methane emission can certainly be an effective solution in reaching the interim targets not only for 2030, but the end goal of a carbon neutral world in 2050. And cutting methane emissions was obviously more on the agenda in COP26. And there have been some very encouraging signs there as well.
\nSo some countries like the US, or some blocs like the EU have actually pledged to cut methane by 30% by 2030 and over 100 countries have signed up to this pledge. There is, however, still a big lack of clarity in regards to the concrete actions to achieve this goal. And this is what you were referring to earlier, also, John about coal. So this is the end goal, and everyone knows that it is going to be better for the ESG profile and the sustainability profiles.
\nBut how can we concretely achieve that and from an investment perspective, there is quite a lot of talk around carbon when we're talking about GHG emissions, but not enough about methane. So how are we going to link this COP26 pledge of cutting methane? And how are we going to incorporate it with the investment process? And what trends are you actually seeing in terms of GHG emission analysis, especially from a scope three perspective?
\nJohn Bates
\nYes Imane, it's a really good question. And I think the answer is partly in the way that you've raised your intro to this part, because I think methane is probably the easiest, quickest fix in terms of greenhouse gas reduction. And as you mentioned, the power of methane in the atmosphere is very, very potent. What we've been seeing in terms of our investment processes, we've been trying to target, if you like, the big offenders, which are the companies that are creating the most in terms of greenhouse gases. And what we found is, that there was an interesting study by CalPERS, which looked at its 10,000 investment holdings, and it found that out of 10,000 investment holdings, 100 accounted for just under half of the emissions generated across the portfolio.
\nSo it just shows you that, if we can tackle the big ones, then I think that's really, really the way forward. And that's where engagement and stewardship comes in. It's where you need a team of analysts that can engage and actually really get to the bottom of what's going on, what's ticking along in a company. And that's really how we're trying to address this whole issue.
\nIn terms of Scope 3 emissions analysis, I think, to be honest, we're a long way away from getting any real answers to that. Just to give you an example, emissions generated by supply chains are largely out of the control of companies. For a typical beverage manufacturer, emissions generated by Scope 3, barley growers, beer can manufacturers, and transport providers produce around 10 times that of the direct emissions from the company itself. Scope 3 is still a very difficult area.
\nImane Kabbaj
\nAs you rightly mentioned, John, we are actually a bit of a long way off having those concrete plans about really having an effect on reducing GHG emissions, whatever types they are. There is obviously a lot being done but clearly not enough for us to be reaching Net Zero.
\nHopefully, both the sovereigns and the corporates will be able to come up with more concrete solutions in the coming years or hopefully even months so that we can reach all of these targets. If we look at like GHG emissions, we have, of course, decided there is the energy transition, which is where everyone is trying to work towards. But we can also look at a more natural way, of “dealing with GHG emissions”, which is using the tools that were given to us by Mother Nature, for lack of a better word.
\nSo if we look at the forests, the forests actually are any sorts of plants and one of the great ways to absorb all the various GHG emissions. And unfortunately, deforestation that has been happening in the past century has accelerated the climate change because it's been hindering the process of the CO2 absorption. So deforestation has definitely been also one of the key agenda items at COP26.
\nAnd over 100 countries have actually pledged to end and reverse deforestation by 2030, Brazil being one of the keys signatories of this pledge, which is interesting if we consider the lack of action by the Brazilian government in the recent Amazon wildfires. But that being said, there is definitely a lot of hope when we talk about deforestation.
\nDeforestation is definitely something that is possible and that is achievable. And we have a concrete example of that. So Costa Rica, for example, is the first country that has succeeded in halting, and in fact, that will be reversing the effects of deforestation. So we have some great learning there from Costa Rica that could be applicable to other parts of the world.
\nAnd this pledge of halting deforestation that has been signed by over 100 countries actually includes over 14 billion pounds of private and public funds. I think it will be interesting to find the link between the deforestation, all of these efforts that are being made and actually what role does biodiversity factors play overall in the ESG investment process and analysis? And how are they taken into consideration?
\nJohn Bates
\nThank you Imane. And yeah, I think you raise a really good point here and you know, the Amazonian rainforest situation is something that we've been watching very closely. I think from a biodiversity perspective, as an investor, there are generally three areas of focus. The first is pollution. The second is global climate change. The third is habitat loss and fragmentation. And then there are other areas as well.
\nBut in terms of deforestation, I think this is one of the real great areas where, as investors, we can really make a big difference in terms of our engagements and impact on some of the companies responsible for this. And the reason for that is, as you say, a lot of these deforestation events are happening in countries that rely very heavily on external financing, so dollar funding.
\nSo Brazil to take a case in point, has a number of the largest beef producers, and Brazil is actually the world's largest beef exporter, the second largest beef producer after the US. So the biggest producers are very substantial dollar corporate bond issuers, and our analysts based in Santiago, have been talking to the beef producers in Brazil for many years now. But what makes this sector so impactful in terms of biodiversity is the feed sourcing, which requires huge amounts of land for grazing, and large amounts of methane is emitted from the animals.
\nSo deforestation is a major issue as the ranchers operate on swathes of this deforested Amazonian land. So we think our position as investors provides us with a really strong leverage point, as these guys are very dependent on our dollar funding that we're providing and not a lot of Brazilian money is in Brazilian beef. A lot of the money is international dollar funding.
\nSo we've been really pushing the beef producers to commit to very specific greenhouse gas targets and no deforestation policy, better transparency. It's an ongoing process, but we're already seeing some good positive results from there with the large producers adopting specific commitments. Most of these companies now have very comprehensive sustainability reporting. They have cattle origin, traceability, they have engagement with the local suppliers. They're becoming actually quite world leading in terms of transparency.
\nActually, just to give you an example, in June, last year, twenty nine asset managers with a combined AUM of nearly 4 trillion threatened the Brazilian government, investment would be jeopardized if better policies were not adopted. The positive action we're seeing is being rewarded with better financing terms, potential credit rating upgrades, and supported long term credit outlook for these companies. It is very much an ongoing thing. But I really do think that the biodiversity angle is something where fixed income investors can actually really make an impact on some of these dollar dependent industries.
\nImane Kabbaj
\nThank you so much, John, for sharing all of your insights and very interesting feedback and comments today. I really enjoyed doing this podcast together.
\nJohn Bates
\nThat brings us to the end of the five points that Imane brought back from COP26. And I think the messages are very clear. It is a very long road to 2050. But as investors, we have a part to play, a very key one and one of the key areas that we can do this is by having an influence on costs of funding across the board.
\nWe've talked about coal, we've talked about deforestation, we even can talked about methane. Positive action is being rewarded with better financing terms, potential credit rating upgrades and supportive long term credit outlook for these companies. I think there's an awful lot that we can learn from that, as investors in particular, that our influence as investors will help drive this road to Net Zero. I hope you've enjoyed the podcast. You can read more about all of this on PineBridge.com. Thanks for listening.
\nENDS
\nApart from a few high-profile credit events, emerging market (EM) corporate debt benefited in 2021 as supportive economic and earnings conditions helped credit spreads grind tighter and deliver positive total returns, despite an increase of US Treasury yields. From a global credit perspective, we still find EM corporate bonds offering attractive value relative to developed market (DM) corporate bonds. But in 2022, selectivity will be paramount. Choosing securities that will outperform will be key in a market where prices, broadly speaking, reflect the supportive fundamental outlook.
\nWe’ve long viewed environmental, social, and governance (ESG) risk considerations as a vital component of active management within the EM corporate bond market and have maintained ESG risk scores on the issuers we cover for more than five years. More recently, though, amid an increasing net-zero push and other initiatives, investors have been bolstering their efforts to manage ESG risks and engage with issuers on meaningful issues of sustainability. The primary objective among investment managers and asset owners is to ensure that their investment capital is used to promote a more sustainable future for the planet and for society. They increasingly understand that mitigating ESG risks can also serve as a valuable tool for downside risk management within portfolios.
\nAnd here’s where we see selective risk-taking and ESG considerations converging in 2022: We expect the evaluation of ESG risks to take on a larger role in identifying securities that will outperform in a market where traditional credit risk appears fairly valued.
\nESG risks have been factored into corporate credit ratings for some time, so it’s natural to assume that ESG ratings are highly related to credit ratings, with a distribution of stronger-rated ESG issuers among the higher-rated credits within a bond market. Among EM corporate bonds, this notion is seemingly supported by the equivalence of average credit rating and average ESG rating (BBB-) of the JP Morgan CEMBI Broad Diversified index.
\nBut you don’t have to look far to uncover anomalies in this presumptive relationship. At the regional level, the Middle East and Asia are the two highest-rated regions within the JP Morgan CEMBI Broad Diversified index, with average credit ratings of BBB. However, the Middle East and Asia are the lowest-rated regions for ESG within the index, with average MSCI ESG ratings of BB+.
\nWhy the disconnect between credit rating and ESG rating? Given the predominance of energy issuers in the Middle East, the divergence may not be surprising, but those issuers have been equally penalized for a lack of ESG transparency at the governance level for their operations’ carbon intensity. And Asia, the largest market within the EM corporate bond universe, features a large concentration of issuers from China, India, and Indonesia -- all of which have thematic issues that come through in ESG ratings. Chinese corporates tend to score lower on social issues, Indian corporates tend to have weaker governance ratings, and Indonesian commodity issuers tend to have higher environmental risks.
\nConversely, the two regions with the lowest credit ratings – Latin America and Sub-Saharan Africa, both BB – are each rated BBB- for ESG. In Latin America, issuers from Brazil, Chile, and Colombia broadly feature some of the strongest environmental and social ratings within the global EM corporate market. Sub-Saharan Africa, the market’s smallest region, benefits at the index level from a high proportion of financial issuers as well as strong governance ratings in its substantial metals and mining sector.
\nAnother reason for the divergence between ESG and credit ratings can be traced to the effect sovereign credit ratings have on corporate credit ratings; rating agencies apply a sovereign rating cap on corporate credit ratings, regardless of stand-alone credit fundamentals. This certainly plays a role in Brazil, but it’s most evident in Turkey, where above-average environmental and social sustainability profiles and historically strong governance factor into a BBB ESG rating for the corporate bond market, while the sovereign’s B rating has translated to an average B corporate credit rating.
![\"Average](\"/_assets/images/articles/charts/outlook/emd-blog-outlook-nov-2021-1.gif\")
Source: JP Morgan, MSCI as of 20 October 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
In a market as diverse as global EM corporate credit, it’s difficult to find broad investment themes that have a strong cross-market relationship to performance. In 2021, excluding idiosyncratic risks in China, EM corporates generally delivered stable, albeit moderate, total returns as credit spreads ground tighter in the face of rising US Treasury yields. And during the year, bonds from issuers with higher ESG ratings than their credit rating outperformed those with worse ESG ratings than their credit rating.
Source: JP Morgan, MSCI as of 20 October 2021. Excludes China property sector and securities with idiosyncratic performance greater than 20% or less than -20% for the year. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change. Given that ESG risk analysis is often said to focus on issues of materiality – factors that can have a material impact on a company’s finances and operations – it’s reasonable to expect solid ESG issuers to outperform. But those factors tend to play out over the longer term and often are more geared toward mitigating downside risks than generating near-term outperformance. More likely, in our view, is that the rise of ESG risk considerations among both asset managers and asset owners is fueling demand for higher ESG-rated issuers.
The relationship between an ESG rating gap and performance was stronger for sectors in which ESG risks are elevated. Environmental risks tend to be areas where asset managers and asset owners prioritize impact, so it’s not surprising that within sectors with heightened environmental risks, such as energy and metals & mining, ESG factors can play a more decisive factor in generating demand and total returns during 2022.
![\"ESG](\"/_assets/images/articles/charts/outlook/emd-blog-outlook-nov-2021-3.gif\")
Source: JP Morgan, MSCI as of 20 October 2021. Excludes securities with idiosyncratic performance greater than 20% or less than -20% for the year. For illustrative purposes only. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
Given the breadth of various risk premia that contribute to market pricing for EM corporate bonds, it can be difficult to quantify ESG risk premium. Given the issues of materiality and greater investor demand, it stands to reason that better ESG credits will pay a lower cost of capital. But what is the proper premium? While the answer may vary case by case, by looking at similarly rated bonds at equivalent points of the curve within a regional subset of an industry, we can observe a clear difference between higher and weaker ESG-rated issuers across several sectors.
![\"Spread](\"/_assets/images/articles/charts/outlook/emd-blog-outlook-nov-2021-4.gif\")
Source: JP Morgan, MSCI as of 20 October 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
This is another area where we believe a comprehensive approach to ESG integration can add alpha: by identifying issuers that are committed to improving their operations’ sustainability and, therefore, their ESG risk rating. We expect the link between ESG risk profile and cost of capital to get stronger as more capital tends to flow into ESG-themed investment strategies. By investing in and engaging with issuers that are at an early stage, but are committed to ESG development, we can not only better achieve our sustainable investment objectives but also enhance performance alpha in our portfolios.
\nAt PineBridge for more than five years we have formally assigned and tracked ESG risk scores to all the EM corporate bond issuers we cover. Such analysis has proven to be a valuable component of our risk management across all portfolios, regardless of investment objective. More recently, we began to consider how a forward-thinking approach to ESG risks could not only enhance our understanding of risk but also potentially contribute to alpha generation. So just over one year ago, we began to assign ESG Trends – which reflect the trajectory of ESG risks over the coming 12 months – to all EM corporate issuers we cover. These proprietary metrics are supplemented by third-party ESG analysis and data, and they form a key component of our investment process across all of our strategies. We have also established a formal engagement framework that provides structure to the ESG issues on which we engage with our issuers and also monitors the frequency, quality, and response of such engagement, which form a core input of our ESG metrics. Taken together, we believe these steps and actions taken by issuers, investment managers, and asset owners on ESG will support the kind of selective risk-taking that taps securities likely to outperform.
\nInvesting involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"2022 EM Debt Outlook: Is ESG a Roadmap to Alpha for Emerging Market Debt?","custom_s_image":"/_assets/images/articles/article-cover-images/2021/11-is-esg-a-roadmap-to-alpha-for-emerging-market-debt.jpg","custom_ss_authors":["80195"],"custom_ss_author_links":["/bio/davis-jonathan"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"Amid an increasing net-zero push, investors have been bolstering their efforts to manage ESG risks and engage with issuers in emerging markets on meaningful issues of sustainability.","custom_s_local_url":"/en/investor-types/default/insights/is-esg-a-roadmap-to-alpha-for-em-debt","score":1.0},{"id":"178183","custom_i_asset_id":178183,"custom_s_title":"Fixed Income Asset Allocation Insights: Wider Spreads May Be Coming, But Not Yet","custom_dt_date":"2021-11-04T00:00:00Z","custom_s_description":"While most credit asset classes generated positive excess returns in October, total returns were negative as Treasury rates traded higher. Emerging market (EM) debt, and particularly EM high yield corporates, remain weak as spreads ballooned due to Evergrande’s troubles and the resulting stress in the Chinese property sector. Among other asset classes, spreads remained very tight.
\nThe fundamental backdrop continues to be largely positive and demand for credit has stayed strong, but we have begun to see evidence of slowing economic growth. Supply bottlenecks and persistent inflation that seems to be spreading beyond the US, as well as China’s current weakness and resulting cuts in estimates of its GDP, have dampened the global economic outlook. In addition, signals from the Fed point to imminent tapering and a reduction of the liquidity provisions put in place during the early days of the Covid pandemic.
\nThese moves, as well as rate hikes coming as early as 2022, are likely to result in higher volatility and wider spreads. While slower growth would likely present an attractive opportunity to shift back to a more risk-on posture, we expect current trends to take some time to fully play out. Against this backdrop, our fixed income allocations remain unchanged.
\n\nMarkus Schomer, CFA, Chief Economist
\nMaintaining a slight overweight to the central case
Our US Macro scenario probabilities are unchanged going into October, with the central case at 45%, bull case at 40%, and bear case at 15%. GDP growth and inflation should remain above the central-case definition in the next 12 months, but the trend should be more clearly heading in that direction. Preliminary October purchasing managers’ indices (PMIs) showed renewed improvement in the recovery momentum driven by stronger services. Consumer confidence also rebounded, pointing to a growth re-acceleration at the start of the fourth quarter. Inflation pressures remain high, but the Consumer Price Index (CPI) should be at its peak; still, significant improvement may still be a few quarters away. The debt-ceiling crisis was postponed, and agreement on the next (and last) fiscal package is near. We are still not convinced the Fed will start tapering this year.
Market movers
Growth scare. The Atlanta Fed’s GDPNow model’s third-quarter forecast has fallen to 0.5%; the Bloomberg consensus is looking for 2.6% growth with a range of 5% to -0.1%. Growth is set to slow significantly from the 6.5% average in the first half, with supply constraints the main retardant. A more sustained weakness could damage confidence in the recovery.
Powell’s moves. The Fed punted on tapering in September but committed to a decision in November. Economic news tilts toward a taper. September retail sales were much stronger than expected, October PMIs rebounded, and inflation remains high. Yet third-quarter GDP likely slowed sharply, and job growth was disappointing.
Fiscal ‘failure.’ It looks like progressives have capitulated and moderates will get their “scaled-down but still enormous” seventh fiscal stimulus package since the start of the pandemic, for a total of $5.5 trillion. Fiscal support for next year should remain strong. The end of fiscal stimulus spending is more relevant for 2023 and 2024 and of course raises the chance of mid-term losses by Democrats.
For illustrative purposes only. We are not soliciting or recommending any action based on this material. There can be no assurance that the above allocations will be in any account at the time this information is presented. This material must be read in conjunction with the Disclosure Statement.
John Yovanovic, CFA, Head of High Yield Portfolio Management
\nFundamentals
Looking through the quarter into 2022, earnings become tougher and S&P 500 and high yield (HY) equities show sales and earnings estimates in the high single-digits to teens. This is more in line with the long-term trend than the volatility we have experienced over the past six quarters. This year has been one of early-cycle fundamentals with late-cycle valuations; 2022 appears to be offering a shift to mid-cycle fundamentals. While third-quarter earnings are just beginning to be reported, revenues thus far have beaten expectations while earnings have met them.
Valuations
Spreads remain rangebound but resilient in the face of rising US Treasury yields. We remain near our model’s option-adjusted spread target of 270-300 basis points (bps). Spreads are fair near-term, but we continue to see merit as the asset class remains attractive relative to the other options. At current spread levels, though, it is unlikely we have enough cushion to fully absorb increases in interest rates. Our spread model continues to suggest 4%-5% annual returns. Carry remains king. BB/B credit is still favored and first-time issuers continue to provide value opportunities.
Technicals
Heavy primary issuance, rates pressure, and outflows result in a neutral technical backdrop that breaks to the downside on occasion. Recent weekly fund flows saw $1.8 billion in outflows, while year-to-date (YTD) outflows total $4.6 billion. Institutions, however, generally are stepping in to buy dips. With issuance of $460 billion YTD through 19 October, we’ve already surpassed last year’s total of $442 billion. We expect these patterns to continue into 2022. (Technicals based on JP Morgan Securities data as of 19 October.)
We maintain our allocation of 35%. Earnings improvement is expected to slow to more normal levels from the sharp recovery earlier this year. Valuations are fair near-term and favor floating-rate loans going into a Fed taper, while investment-grade (IG) collateralized loan obligation (CLO) debt also remains attractive. Fair value and improving fundamentals mean we still favor credit, keeping portfolio risk around a beta of 1.0.
\nDana Burns, Portfolio Manager, US Dollar Investment Grade Fixed Income
\nFundamentals
Fundamentals have improved with net leverage now below pre-Covid levels and rising stars expected to well outpace fallen angels in 2022. Nevertheless, we remain concerned about margin pressure in the industrial sector due to rising input costs. The reopening of economies continues to drive demand.
Valuations
Credit spreads remain at the tighter end of the range. Nevertheless, all-in yields are still attractive to investors. Select credits and sectors remain attractive.
Technicals
The technical backdrop for credit has softened due to a reduction in foreign demand. However, low broker-dealer inventories (which are negative in the five- to 10-year bucket) remain. Near-term concerns surrounding Fed policy may slow demand.
Roberto Coronado, Portfolio Manager, Non-US-Dollar Investment Grade Credit
\nFundamentals
Neutral. Companies generally continue to beat expectations while net leverage is slightly below 2019 levels, and hence balance sheets remain in good shape. We continue to monitor the merger and acquisition (M&A) activity given the recent increase but are still comfortable with the credit metrics.
Valuations
Neutral. Credit spreads are close to fair value at the index level, so we don’t expect a large move tighter, but similarly we don’t see a reason for them to widen as long as the European Central Bank (ECB) retains its quantitative easing program. We believe sector and security selection will be the way to outperform.
Technicals
Positive. The technical picture has remained supportive thanks to the continuous buying from ECB programs and the strong inflows into the asset class since the summer.
We maintain our allocation of 20%. Near term, we have reduced risk exposure in the portfolio due to valuations and the Fed contemplating a reduction of its accommodative measures. Nevertheless, we continue to be constructive on US dollar investment grade credit and continue to look for opportunities on any weakness.
\nAnders Faergemann, Portfolio Manager, Emerging Markets Fixed Income
\nFundamentals
Robust fundamentals in emerging markets (EMs) are expected to offset lingering concerns about a China slowdown. A strong economic recovery in EM in the fourth quarter outside of China is also expected to compensate for weaker growth in China, related to curbs on the property sector and power shortages to meet carbon-emission targets. We don’t anticipate a universal policy easing in China this year.
Valuations
Sovereign spreads have widened approximately 20 bps in the recent wobble yet maintain a positive tone within a narrow range of +340 to 360 bps over US Treasuries. The overall index is at +357 bps, IG at +149 bps, and HY at +599 bps. Sovereign IG spreads are close to our estimated fundamental fair value, while sovereign HY spreads now offer an attractive entry point and higher-than-usual return expectations. (Valuations based on JP Morgan and Bloomberg data as of 25 October.)
Technicals
EM suffered minor outflows in the quarter-end jitters, yet we don’t expect any significant outflows amid the Fed’s taper announcement if the global growth recovery remains intact. JP Morgan’s new-issuance expectations of US$60 billion before year-end appear far too optimistic in our view (as of 25 October).
Steven Cook, Co-Head of Emerging Markets Fixed Income
\nFundamentals
Our scores remain unchanged as third-quarter earnings start arriving. After improvements in EBITDA and net leverage in the second quarter, we expect leverage to fall further as the year ends, confirming our positive credit outlook. We will be looking for guidance on costs and 2022 outlooks.
Valuations
Spreads-to-worst on the CEMBI Broad Diversified are up 7 bps over the last month to 260 bps, with HY up 13 bps and IG up 3 bps. HY was driven by 150 bps of net widening in China. Still, we retain our bullish scores, contending the market is currently mispricing the default risk on our coverage in Asia and the limited contagion risk to the broader market offers a spread pickup versus other asset classes. (Valuations based on JP Morgan data as of 19 October.)
Technicals
Issuance has dropped, with $14 billion of new supply month-to-date (MTD) versus an average of $44 billion for October. Over 70% MTD has been IG (versus 63% YTD) and Asia accounted for only 34% (versus 58% YTD). Expected issuance in Asia in the fourth quarter was lowered to $45 billion from $66 billion in coupons and repayments. We maintain our scores given that fund flows have been relatively unaffected, supply expectations have been lowered, and new allocations are being directed to the asset class. (Technicals based on JP Morgan data as of 18 October.)
We maintain our allocation of 25%. Despite a market wobble in September and October due to Fed taper speculation and a self-induced China slowdown, EM fundamentals remain strong, underpinned by the global growth recovery and healthy current and fiscal accounts. Overall, spreads are attractive on a relative basis, yet the time of year may warrant caution on technicals.
\nAndrew Budres, Portfolio Manager, Securitized Products
\nFundamentals
Fundamentals are still challenging. Mortgage rates are going higher, but so much housing appreciation exists that borrowers need not be “in the money” to want to be able to refinance to extract some equity at low rates.
Valuations
Spreads have already taken a taper into consideration. Higher rates or steeper curves should be good for mortgage-backed securities (MBS) spreads.
Technicals
MBS supply will be much lower in 2022 versus the record this year, but a hot housing market will keep the mortgage churn ongoing as home sales spur refinancings and new loans.
We maintain our allocation of 20%. MBS performance over most of 2021 was a pull-forward of taper expectations, gapping tighter on clarity from the Fed. Higher rates were the exact prescription needed for MBS to start recording positive performance; now they are proving to be a stronger force than the imminent reduction of Fed buying.
\nDmitri Savin, Portfolio Manager, Portfolio and Risk Strategist, Emerging Markets Fixed Income
\nFundamentals
The extent of central bank decoupling that has been discounted by the markets can be difficult to judge, yet a Fed taper has been well telegraphed and does not justify changing our 12-month euro/US dollar forecast. Other US dollar-supportive factors, such as the relative output gap and a long-awaited normalization of real yields, are slow-burning and warrant additional time before leading to a change in outlook.
Valuations
For now, we maintain our forecast of 1.1750 within a 1.1500-1.2000 range for the next 12 months. We are neutral on the euro, have a 12-month forecast range of 110-115 for the US dollar/Japan yen, and favor being underweight the yen.
Technicals
According to JP Morgan and International Monetary Market data through 22 October, positioning changes for the week ending 19 October were defined by pro-cyclical rotation. Last week, the largest positioning improvements were unwinds of the Canadian dollar and the Australian dollar’s net shorts. The British pound also built out net length from neutral levels. Meanwhile, the low-yielding Japanese yen and Swiss franc saw significant extensions of shorts. (Bloomberg data as of 22 October.)
We maintain our 0% non-dollar allocation. While the balance of risk may be tilted toward a stronger US dollar for the near term, technical factors suggest the momentum could be fading as we head into next year.
\n![\"Fixed](\"/_assets/images/articles/charts/fiaai/2021/fixed-income-asset-allocation-insights_october-2021-b.gif\" "\\"Our")
Source: PineBridge Investments. For illustrative purposes only. Any opinions, projections, forecasts and forward-looking statements are based on certain assumptions (which may differ materially from actual events and conditions) and are valid only as of the date presented and are subject to change.
\n\nFixed Income Asset Allocation Insights is a monthly publication that brings together the cross-sector fixed income views of PineBridge Investments. Our global team of investment professionals convenes in a live forum to evaluate, debate, and establish top-down guidance for the fixed income universe. Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the global fixed income market.
","custom_s_image_alt":"Fixed Income Asset Allocation Insights: Wider Spreads May Be Coming, But Not Yet","custom_s_image":"/_assets/images/articles/article-cover-images/2021/11-fiaat-oct-27-2021.jpg","custom_ss_authors":["80545"],"custom_ss_author_links":["/bio/vanden-assem-robert-cfa"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"The fundamental backdrop continues to be largely positive and demand for credit has stayed strong, but we have begun to see evidence of slowing economic growth. While this would likely present an attractive opportunity to shift back to a more risk-on posture, we expect current trends to take some time to fully play out. Against this backdrop, our fixed income allocations remain unchanged.","custom_s_local_url":"/en/investor-types/default/insights/fixed-income-asset-allocation-insights-october-2021","score":1.0},{"id":"177643","custom_i_asset_id":177643,"custom_s_title":"Leveraged Finance Asset Allocation Insights: Headwinds Meet Tailwinds","custom_dt_date":"2021-10-29T00:00:00Z","custom_s_description":"Spreads on high yield bonds and bank loans traded sideways in October as investors continued to balance improving corporate earnings against the prospect of higher inflation that would trigger a move toward less accommodative monetary policies from the Fed and other central banks.
\nOn the positive side, economic growth has led to improved leverage metrics. In addition, demand for credit remains robust, with markets easily absorbing elevated new issuance and governments and central banks continuing to pursue supportive fiscal and monetary policies. On the negative side, we are seeing signs of slowing growth in the US accompanied by stubborn inflation; the potential for turmoil in the Chinese property sector, which could lead to slower growth in China and globally; and US Treasury rates increasing markedly, with overnight index swap (OIS) forwards now pricing in at least one if not two Fed rate hikes in 2022.
\nIn many ways, however, these developments tend to counterbalance each other. In China, the government reinforced its commitment to an orderly restructuring of Evergrande and the real estate sector. Nonetheless, economists have slashed their estimates for Chinese GDP growth and, as a result, global GDP growth. Against that backdrop, while US Treasury yields likely have bottomed from a secular perspective, the magnitude of any rise in yields seems manageable due to our expectation of cresting global growth as a result of China’s problems.
\nWith these offsetting forces in place, we expect negative real rates will continue to incentivize investors to reach for yield and believe leveraged finance asset classes will remain attractive options relative to other fixed income alternatives.
\nThe following sections reflect the investment team’s views on the relative attractiveness of the various segments of below-investment-grade corporate credit. Conviction scores are assigned on a scale from 1 to 5, with 1 being the highest conviction.
\nKevin Wolfson
Portfolio Manager,
US Leveraged Loans
CS 2.8 (unchanged)
\nFundamentals: Early third-quarter earnings results point to continued year-over-year (y/y) gains, though probably more muted than in the first two quarters. Risk is increasing in the loan market, with recent new-issue transactions coming with a higher level of first liens and total leverage than earlier in the year. On the institutional side of the business, 91% of year-to-date (YTD) issuance has been covenant-light, topping 2017’s previous high in the mid-70% area (S&P as of 20 October). Notwithstanding worsening new-issue credit quality, issuers’ ample liquidity and positive earnings growth should keep default rates low. The last-12- month (LTM) default rate by principal amount of the S&P/LSTA Leveraged Loan Index finished September at 0.35%. With the roughly $2.7 billion default of a global pharmaceutical company rolling off the 12-month trailing figure in October, the default rate should continue to track lower near term.
\nValuations: Loan yields are at all-time lows, driven by the limited contribution from their Libor reference rate. Though spreads have tightened over the course of the year, they remain above their 2018 levels. From 14 September to 19 October, the spread-to-maturity for the S&P/LSTA Leveraged Loan Index was essentially unchanged at L+400. Spreads for liquid loans, as well as BB- and single-B rated loans, remain essentially unchanged as well. CCC rated loans have widened approximately 22 basis points (bps) over the same period. Although not compelling on an absolute basis, loan spreads still appear somewhat attractive on a risk-adjusted basis versus other debt asset classes. (Valuations based on S&P/LCD data as of 19 October.)
\nTechnicals: Continuing demand from collateralized loan obligation (CLO) issuance and retail inflows have created supportive technicals. New-issue supply, while elevated, has slowed slightly from the previous month. The net forward calendar stood at roughly $41 billion as of 13 October (S&P). Through mid-October, the market reached record levels of loan issuance, merger and acquisition (M&A)-related issuance, and issuance related to dividend recaps. More than offsetting this is record demand from CLO investors, as well as the continuation of positive retail fund flows.
\nJohn Yovanovic, CFA
Head of High Yield
Portfolio Management
CS 3.0 (unchanged)
\nFundamentals: Looking into 2022, sales and earnings estimates for the S&P 500 and high-yield (HY) equities are in the high single-digits to teens, which is more in line with the long-term trend than the volatility seen over the past six quarters. Where 2021 was the year of early-cycle fundamentals versus late-cycle valuations, 2022 is looking to be a year of mid-cycle fundamentals. We’re very early in the third-quarter earnings season, but so far revenues have beaten expectations while earnings have met them.
\nValuations: Spreads remain range-bound but resilient in the face of rising US Treasury yields and near the 270-300 option-adjusted spread (OAS) target of our spread model. Spreads are fair near-term but we continue to see merit, as the asset class remains attractive relative to the other options. At current spread levels, though, the cushion is likely insufficient to fully absorb any increases in interest rates. Our spread model continues to suggest 4%-5% annual returns. Carry remains king. We continue to favor BB/B credit, and first-time issuers continue to provide value opportunities.
\nTechnicals: Heavy primary issuance, rates pressure, and outflows result in a neutral technical backdrop that breaks to the downside on occasion. Fund flows recently saw a $1.8 billion outflow, bringing outflows to $4.6 billion YTD. Institutions, however, generally step in and buy dips. We’ve already surpassed last year’s $442 billion of issuance with $460 billion YTD, and we expect these trends to continue into 2022. (Technicals based on JP Morgan Securities data as of 19 October.)
\nLaila Kollmorgen, CFA
Portfolio Manager, CLO Tranche
CS 2.6 (unchanged)
\nFundamentals: CLO fundamentals, in general, remain good across all metrics. With lower anticipated defaults in the US combined with active management and good credit selection, we expect CLO fundamentals to improve.
\nValuations: BBBs are at 250 to 425, BBs at 515 to 775, and single-Bs at 700 to 1,050. BBB rated CLOs are fair value compared to HY OAS at 290 and to BB rated leveraged loans at 290. BB rated CLOs are trading wide of single-B HY at 325 and leveraged loans at 410 on an OAS basis. The three-month cross-currency Japan yen-US dollar basis is approximately -23 bps as of 19 October, which is 15 bps more expensive over the month, with longer-term cross-currency hedges also having increased in cost over the month. US dollar assets are at their least attractive YTD for Japanese buyers. (Valuations based on Bloomberg and S&P/LCD data as of 19 October.)
\nTechnicals: Demand remains and continues to support spreads. Supply continues to be heavy, which we believe will remain the case for the next few months.
\nEvangeline Lim
Portfolio Manager,
European Leveraged Finance
CS 2.7 (unchanged)
\nFundamentals: There has been a moderation in growth in the euro-area economy following strong growth between June and August. Rising prices have cooled demand while supply chain issues constrain business activity. Nevertheless, we continue to see growth across all sectors, with services growing at a faster rate than manufacturing for the first time since the start of the pandemic. Business confidence remains elevated despite a drop in the level of optimism in the last two months. The services sector is expected to be the key driver of a sustained recovery, as supply shortages will likely continue to subdue manufacturing well into 2022.
\nValuations: On the back of the recent weakening in euro-denominated HY, some single-B bonds are looking cheap compared to the loans in the same rating category. However, loans continue to look attractive in the context of the low volatility, low default outlook and income protection from rising interest rates.
\nTechnicals: The widely telegraphed large new-issuance pipeline has not materialized. Instead, we have seen a drip feed of new loan issues to meet the steady demand from new CLOs and CLO warehouses. The quality of the new-issue loans has been mixed at best, and investor discrimination is reflected in bifurcated pricing. There has been little to no evidence of material flows into separately managed accounts, which usually is detectable from the strong demand for higher-rated loans with low spread.
\nEvangeline Lim
Portfolio Manager,
European Leveraged Finance
CS 3.0 (unchanged)
\nFundamentals: There has been a moderation in growth in the euro-area economy following strong growth between June and August. Rising prices have cooled demand while supply chain issues constrain business activity. Nevertheless, we continue to see growth across all sectors, with services growing at a faster rate than manufacturing for the first time since the start of the pandemic. Business confidence remains elevated despite a drop in the level of optimism in the last two months. The services sector is expected to be the key driver of a sustained recovery, as supply shortages will likely continue to subdue manufacturing well into 2022.
\nValuations: Euro-denominated HY bonds, especially in the lower-quality B and CCC categories, appear attractive compared to euro loans.
\nTechnicals: A combination of trickling outflows, a steady new-issue supply pipeline, and single-name idiosyncratic moves that drove sentiment downward has led to softening in the euro-denominated HY market over the past month. Spread decompression between BBs and single-Bs is evident, as is the underperformance vis-à-vis the US HY market.
\nLaila Kollmorgen, CFA
Portfolio Manager, CLO Tranche
CS 3.0 (unchanged)
\nFundamentals: European CLO fundamentals remain good month-over-month. Active CLO management, combined with good credit selection, continues to show up in positive tailwinds for CLO fundamentals.
\nValuations: BBBs are at 300 to 475, BBs at 600 to 825, and single-Bs at 700 to 935. BBB rated CLOs are fair value to BB rated HY and leveraged loans, while BB CLOs are cheap to European HY and leveraged loan single-Bs. European CLOs benefit from a Euribor floor of zero, which adds about 55 bps to the yield of European CLOs. The current euro/US dollar three-month swap, at about -22 bps, means that European CLO tranches remain attractive vis-à-vis US CLOs, but less than previously. (Valuations based on Bloomberg and S&P/LCD data as of 19 October.)
\nTechnicals: As in the US, primary supply looks set to rise in the next few months. In contrast to the US, however, the size of the European investor base is smaller, and we could see spreads widening on the back of heavy supply.
\nSteven Cook
Co-Head of Emerging
Markets Fixed Income
CS 2.5 (unchanged)
\nFundamentals: We retained our scores as third-quarter reports start coming in. Leverage is expected to decline further in the fourth quarter, supporting our positive credit outlook. We will be looking for guidance on cost pressures and outlooks for next year.
\nValuations: The spread-to-worst on the CEMBI Broad Diversified rose 7 bps over the last month to 260 bps, with HY (up 13 bps) underperforming investment grade (up 3 bps). The HY move was driven by extreme widening in China – 350 bps wider on the month, despite retracing over negative 200 bps month-to-date (MTD) – on the moves in large benchmark names. We retain our bullish score based on our view that the market is currently mispricing default risk in Asia and that contagion risk to the broader market is limited, offering a spread pickup versus other asset classes. (Valuations based on JP Morgan data as of 19 October.)
\nTechnicals: Issuance declined this month, with $14 billion of supply MTD versus an average $44 billion for October. Over 70% of the MTD issuance has been IG (versus 63% YTD), and Asia accounted for only 34% of the total versus 58% YTD. Expected issuance in Asia in the fourth quarter was lowered to $45 billion versus $66 billion in coupons and repayments. We maintain our scores because fund flows haven’t been affected significantly, supply expectations are being lowered, and we still see new allocations to the asset class. (Technicals based on JP Morgan data as of 18 October.)
\nLeveraged Finance Asset Allocation Insights is a monthly publication that brings together cross-sector views within our leveraged finance fixed income group. Our global team of investment professionals convenes in a live forum to evaluate, debate, and establish top-down guidance for the asset classes that make up the leveraged finance investment universe. Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the leveraged finance market.
\nThe information presented herein is for illustrative purposes only, represents a general assessment of the markets at a specific time, and is not a guarantee of future performance results or market movement. It does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; or a recommendation for any investment product or strategy. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. PineBridge Investments does not approve of or endorse any republication of this material. In addition, the views expressed may not be reflected in the strategies and products that PineBridge offers.
","custom_s_image_alt":"Leveraged Finance Asset Allocation Insights: Headwinds Meet Tailwinds","custom_s_image":"/_assets/images/articles/article-cover-images/2021/10_lfaai_oct2021.jpg","custom_ss_authors":["80188"],"custom_ss_author_links":["/bio/oh-steven"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"With offsetting positive and negative forces driving markets, we expect negative real rates will continue to incentivize investors to reach for yield – making leveraged finance asset classes attractive versus other fixed income options. ","custom_s_local_url":"/en/investor-types/default/insights/leveraged-finance-asset-allocation-insights-headwinds-meet-tailwinds","score":1.0},{"id":"176376","custom_i_asset_id":176376,"custom_s_title":"Fixed Income Asset Allocation Insights: Trimming Risk and Keeping Dry Powder on Hand","custom_dt_date":"2021-10-08T00:00:00Z","custom_s_description":"As Treasury rates traded higher in September in response to the Federal Reserve’s firmer stance on tapering, most fixed income asset classes generated negative total returns, but positive excess returns. Lower-duration and floating-rate asset classes generally outperformed. In addition, investors continued to contend with lower growth prospects due to the ongoing spread of the Delta variant and resulting supply chain disruptions. Nevertheless, market conditions remain largely favorable as the fundamental backdrop continues to improve, albeit at a slower pace, and high levels of issuance have been met by continued strong demand.
\nThe primary exception has been in emerging markets (EM), where the Chinese regulatory reset and unfolding Evergrande situation have shaken investors and caused the asset class to lag other credit markets. However, our view is that the spillover to the broad EM sector from a possible Evergrande default would be limited and that market concerns over systematic risk in the Chinese property sector are overblown. Ultimately, fundamentals have continued to improve across most emerging markets, and we believe the recent spread widening caused by concern over China has created attractive opportunities within EM debt relative to other fixed income asset classes, though security selection remains critical.
\nAgainst this backdrop, we have reduced our high yield and investment-grade corporate allocations in favor of high-quality short-duration government securities. Valuations in both markets are at the tighter end of our ranges, and with expectations of increased periods of volatility due to a more hawkish tilt from the Fed and other central banks, we believe it’s prudent to reduce risk and to have dry powder on hand to act during periods of weakness.
\n\nMarkus Schomer, CFA, Chief Economist
\nIncrease in bear case scenario signals a rise in downside risks
We reduced our bull case and increased our bear case going into October, signaling that the downside risks to our US macro outlook have increased. We expect growth to trend back to the central case in early 2023 (not in mid-2022, as projected last month), and inflation should be back by the middle of next year. Purchasing managers’ indices (PMIs) continue to track a slowdown in recovery momentum. Inflation pressures should be peaking, but even the Fed admits that “transitory” may last longer than expected. The near-term fiscal crisis should get resolved, but the time of large-scale fiscal spending programs seems over. We are still not convinced that Fed tapering will start this year.
Market movers
Debt ceiling. Another debt-ceiling crisis is looming, and this time it’s not only Republicans versus Democrats but Democrats versus Democrats. In a debt ceiling crisis, both actors – the one favoring an extension and the one obstructing it – lose out. So, in a Republican versus Democrat standoff, no one gains. But a Democrat versus Democrat standoff could seriously damage the losing faction of Democrats and leave Republicans unscathed.
Powell. The September Federal Open Market Committee (FOMC) meeting was the high point for the Fed’s rhetorical tightening. We moved from talking about the start of tapering to talking about its end (in mid-2022), and the dot plot showed another hike in future rates. But Chair Jerome Powell did not pull the taper trigger. Will he have the courage to announce the start in November, when even darker clouds weigh on the outlook?
Second half. In August, the Atlanta Fed’s GDP model still showed third-quarter growth estimates around 6%. In early September, however, that estimate had fallen to 3.75%; at the end of the month, the forecast had slipped to 3.15%. Could growth fall below 3%? And will the Fed start tapering into a more-severe-than-expected slowdown?
For illustrative purposes only. We are not soliciting or recommending any action based on this material. There can be no assurance that the above allocations will be in any account at the time this information is presented. This material must be read in conjunction with the Disclosure Statement.
John Yovanovic, CFA, Head of High Yield Portfolio Management
\nFundamentals
For 2022, sales and earnings estimates for the S&P 500 and high yield (HY) equities are in the high single-digits, which is more in line with the long-term trend. The still positive, flattening trend should see more sector differentiation.
Valuations
Rising prices plus minor increases in US Treasury yields are driving option-adjusted spreads (OAS) on the Bloomberg US Corporate High Yield Index, at 280 as of 15 September, back to the tight end of their recent range and near the 270-300 OAS target of our spread model. Spreads are fair near term, but we continue to see merit as the asset class remains attractive relative to the other options. BB/B credit remains favored, and first-time issuers continue to provide value opportunities.
Technicals
Primary issuance remains heavy and has picked up again as expected. To date, issuance puts us on pace to meet or exceed the September average. Fund flows have returned at the margin but aren’t dominant. JP Morgan and Bank of America Merrill Lynch continue to forecast an increase in net supply leading to continued growth of the universe. The steady new-issue calendar and rangebound spreads lead to neutral market technicals, with sharp downside moves possible in specific issuers or during volatility events.
We reduced our allocation to 35% from 40%. Primary issuance remains heavy, and 2021 should easily surpass 2020’s issuance record. While the fundamental backdrop is still strong, the rate of improvement has slowed. Despite tight valuations, we remain constructive on leveraged finance asset classes. Going into a Fed taper, we maintain a slight preference for floating-rate loans vis-à-vis high-yield bonds.
\nDana Burns, Portfolio Manager, US Dollar Investment Grade Fixed Income
\nFundamentals
Fundamentals have improved as the economy gets back on track. Nevertheless, concern over margin pressure due to rising input costs remains in the industrial sector. The reopening of economies continues to drive demand.
Valuations
While credit spreads remain at the tighter end of the range, all-in yields remain attractive to investors, as do select credits and sectors.
Technicals
The technical backdrop for credit has softened due to a reduction in foreign demand. However, low broker-dealer inventories (which are negative in the five- to 10-year bucket) remain. Near-term concerns surrounding Fed policy may slow demand.
Roberto Coronado, Portfolio Manager, Non-US-Dollar Investment Grade Credit
\nFundamentals
Neutral. Overall, companies continue to beat expectations while net leverage has not increased, keeping balance sheets in good shape. The only potentially troublesome area is a recent increase in mergers and acquisitions, which merits monitoring in coming months.
Valuations
Neutral. Credit spreads are close to fair value at the index level, so we don’t expect a large move tighter. Similarly, we don’t see a reason for spreads to widen as long as the European Central Bank (ECB) maintains its quantitative easing program. We view sector and security selection as the way to outperform.
Technicals
Positive. The technical picture has remained positive thanks to continuous buying from the ECB through its support programs and strong inflows into the asset class during July.
We have raised our allocation to 20% from 15%. Near term, we have reduced risk exposure in the portfolio due to valuations and the Fed contemplating a reduction of its accommodative measures. Nevertheless, we continue to be constructive on US dollar investment grade credit and continue to look for opportunities on any weakness.
\nAnders Faergemann, Portfolio Manager, Emerging Markets Fixed Income
\nFundamentals
The combination of China’s regulatory crackdown and the targeted slowdown of the Chinese property sector is expected to slow China’s economy considerably in the fourth quarter, yet the authorities stand ready to provide countermeasures should growth forecasts for 2022 drop below 5%. The rest of Asia is expected to grow faster in 2022 than in 2021, and the remainder of EM should see growth above the long-term average.
Valuations
Sovereign spreads continue to trade in a narrow range, despite being unable to keep pace with US Treasuries in September. The overall EMBI Global Diversified is back at +352 basis points (bps), with investment-grade (IG) spreads at +149 bps and HY at +587 bps (JP Morgan and Bloomberg data as of 27 September). Sovereign IG spreads are close to our estimated fundamental fair value, while sovereign HY spreads still have scope to tighten in tandem with improving fundamentals.
Technicals
Concerns over a repeat of the 2013 taper tantrum seem unfounded, as economic growth remains robust and the actual announcement has been very well telegraphed. Flows into EM have remained stable. September saw a pickup in new issuance, and October may carry on in the same vein if sentiment allows.
Steven Cook, Co-Head of Emerging Markets Fixed Income
\nFundamentals
We left our scores unchanged given the positive skew in credit trajectories. Among the 306 names within our coverage that have reported second-quarter or first-half numbers, positive six-month credit outlooks outnumber negative outlooks by nearly three to one. The main change over the month is the increase in default expectations with the inclusion of Evergrande, which is the main reason JP Morgan moved its 2021 default expectations from 2.4% to 5.5%; ex China, the full-year expected default rate is 1.8%, as of 13 September.
Valuations
Also unchanged. Spreads-to-worst (STW) on the CEMBI Broad Diversified have widened slightly (by 2 bps) over the last month to 256 bps and by 8 bps quarter-to-date. Month-to-date, HY underperformed IG slightly (up 9 bps versus down 3 bps), mainly driven by China HY, which was up 242 bps. We retain a bullish longer-term score given the spread pickup on offer versus other asset classes. (Valuations data from JP Morgan as of 28 September.)
Technicals
September new issuance, at $52 billion, of which 60% was IG (versus 63% year-to-date), is being well digested given higher cash levels, which we expect to continue. Year-to-date issuance of $433 billion is up 10% year-over-year. We retain our bullish score based on continuing demand-side inflows due to new allocations. (Technicals data from JP Morgan as of 27 September.)
We maintain our allocation of 25%. While we expect the Chinese economy to slow in the fourth quarter, the rest of EM is expected to grow above its long-term average in 2022. Overall, spreads are attractive on a relative basis and fundamentals remain strong, yet the time of year may warrant some caution on technicals.
\nAndrew Budres, Portfolio Manager, Securitized Products
\nFundamentals
Fundamentals remain challenging. Mortgage rates are off their record lows, but still low on an absolute basis, and mortgage originators are still able to find customers easily.
Valuations
Spreads have already taken into consideration an imminent taper. Higher rates or steeper curves should be good for spreads on mortgage-backed securities (MBS).
Technicals
Supply of MBS in the year was much higher than anyone expected. Next year, supply will likely be much lower, setting up a positive technical picture for 2022.
We maintain our allocation of 20%. Much of the pain of the anticipated Fed taper has already taken place and is priced into MBS spreads. As counterintuitive as a taper being positive may seem, MBS investors welcome the finality of it. If higher rates ensue, MBS should perform well into steeper curves and a drop in refinancings.
\nDmitri Savin, Portfolio Manager, Portfolio and Risk Strategist, Emerging Markets Fixed Income
\nFundamentals
Supporting factors for the US dollar have dissipated in recent months with growth dynamics changing in favor of Europe and the urgency for Fed tapering being slightly reduced. The rise of the Delta variant in the US has been used as an excuse for the recent dampening of the US economic outlook, yet US growth remains above the long-term average, supporting a view that the output gap will close by the end of the year.
Valuations
We believe the US dollar can gain more against the euro and the Japanese yen once real yields start to rise and breakevens tighten, but the onset of that has been delayed by the change in growth prospects. For now, we maintain our forecast of 1.1750 within a 1.1500-1.2000 range for the next 12 months within a neutral bias.
Technicals
According to JP Morgan and International Monetary Market data through 24 September, futures investors added US dollar length before the September FOMC meeting. Meanwhile, euro net positioning has shifted to notionally flat, while Canadian dollar gross length has been wiped out. The euro’s net positioning levels of just +1.5 billion is the closest it has been to neutral since the rapid flip to net length during the deleveraging period last year.
We maintain our 0% non-dollar allocation. The recent change in growth dynamics in favor of Europe has put our view that the US dollar could gain more against the euro on hold. As a result, we maintain a neutral bias on the US dollar over the next 12 months.
\n![\"Fixed](\"/_assets/images/articles/charts/fiaai/2021/fixed-income-asset-allocation-insights_september-2021-b.gif\" "\\"Our")
Source: PineBridge Investments. For illustrative purposes only. Any opinions, projections, forecasts and forward-looking statements are based on certain assumptions (which may differ materially from actual events and conditions) and are valid only as of the date presented and are subject to change.
\n\nFixed Income Asset Allocation Insights is a monthly publication that brings together the cross-sector fixed income views of PineBridge Investments. Our global team of investment professionals convenes in a live forum to evaluate, debate, and establish top-down guidance for the fixed income universe. Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the global fixed income market.
","custom_s_image_alt":"Fixed Income Asset Allocation Insights: Trimming Risk and Keeping Dry Powder on Hand","custom_s_image":"/_assets/images/articles/article-cover-images/2021/10-fiaat-sept-29-2021.jpg","custom_ss_authors":["80545"],"custom_ss_author_links":["/bio/vanden-assem-robert-cfa"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"Market conditions remain largely favorable, but with expectations of increased periods of volatility due to a more hawkish tilt from central banks, we are reducing high yield and investment-grade corporate allocations in favor of high-quality short-duration government securities, as valuations in the former two markets are at the tighter end of our ranges.","custom_s_local_url":"/en/investor-types/default/insights/fixed-income-asset-allocation-insights-september-2021","score":1.0},{"id":"175148","custom_i_asset_id":175148,"custom_s_title":"Asia High Yield: Four Reasons to Consider This Compelling Market","custom_dt_date":"2021-09-29T00:00:00Z","custom_s_description":"Asia high yield has become an important component of the global emerging markets (EM) high yield universe in recent years. Yet investors’ access to a standalone allocation to Asia US dollar high yield remains limited. Exposures typically form a small portion of global or EM high yield fixed income portfolios.
\nDespite recent default concerns in the Chinese property sector, Asia high yield bonds remain a compelling investment, offering higher yields and lower interest rate sensitivity than global peers. However, investors should exercise selectivity via a thorough credit research to find the ‘sweet spots’ in the market and build a resilient portfolio that can ride out short-term volatility.
\nValuations remain cheap compared to the long-term average, offering an attractive entry point and room for potential capital appreciation.
![\"Asia](\"/_assets/images/articles/charts/asia-hy-1.gif\")
Source: J.P. Morgan, Bloomberg, PineBridge Investments as of 28 Sept 2021. Asia HY Credit Spread is represented by the JACI Non-Investment Grade Index. For illustrative purposes only. Any opinions, projections, forecasts, or forward-looking statements presented are valid only as of the date indicated and are subject to change. We are not soliciting or recommending any action based on this material.
Asia high yield bonds offer better yield and shorter duration than global peers, which make them less sensitive to potential interest rate hikes.
![\"Asia](\"/_assets/images/articles/charts/asia-hy-3.gif\")
Source: Bloomberg, PineBridge Investments as of 30 June 2021. Any opinions, projections, forecasts, or forward-looking statements presented are valid only as of the date indicated and are subject to change. We are not soliciting or recommending any action based on this material. Duration is a measure of the bond’s sensitivity to changes in interest rates. Yield refers to the rate of return if bonds are held to maturity. The rate of return includes the coupon payments received during the term of a bond and its principal repayment upon maturity.
The underlying credit profiles of Asia credits in general continue to improve or remain steady. Given current credit spreads,* we believe the market has assumed too much default risk and we see this is as an opportunity for value hunting as the market is too bearish relative to credit fundamentals.
![\"Selective](\"/_assets/images/articles/charts/asia-hy-2.gif\")
Source: BofA Merrill Lynch, PineBridge as of 31 August 2021. For illustrative purposes only. Any opinions, projections, forecasts, or forward-looking statements presented are valid only as of the date indicated and are subject to change. We are not soliciting or recommending any action based on this material. Past performance, or any prediction, projection or forecast, is not indicative of future performance. *Credit spread is the difference in yield between a U.S. Treasury bond and another debt security of the same maturity but different credit quality.
The market is underpinned by the region’s healthy long-term macroeconomic fundamentals. The International Monetary Fund expects emerging and developing Asian economies to grow 6.4% in 2022, faster than the global average as well as advanced economies.1 China’s growth this year is expected to remain at low to mid 8%. Over the long term, structural trends such as digitalization, green energy, and urbanization are seen as key drivers of the region’s sustained growth.
\nAs investors pursue better yield and capital protection in difficult markets, we believe the Asia high yield market offers plenty of value, especially for those able to navigate across credit ratings, sectors, and markets. Balancing yield and risk will be key.
\nActive credit selection based on comprehensive credit research and manager experience allows for more nimble risk positioning along the yield curve as conditions evolve. We believe an approach that goes beyond market capitalization or credit rating screening, with a focus on issuer fundamentals sector and macroeconomic cycles, and environmental, social and governance (ESG) considerations, may enhance income generation and capital appreciation.
\nWith Chinese property issuers a major component of the Asia high yield market, stringent credit selection is important to avoid potential default exposures as recent borrowing restrictions may strain overleveraged players. However, we believe the regulatory tightening will be positive for the sector in the longer term.
\nIn addition, Asia’s emerging market for sustainability-linked bonds is also poised to provide potential new opportunities that have not been widely available to date in Asia high yield. This segment has seen a mini-boom over the past year, as corporates tapped ESG-dedicated institutional capital to finance green projects as governments also race to reduce carbon emissions.
\nAn actively managed standalone allocation to Asia high yield can help maximize the rising income and growth opportunities in this highly dynamic market.
\n1 IMF as of July 2021.
\nInvesting involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"Asia High Yield: Four Reasons to Consider This Compelling Market","custom_s_image":"/_assets/images/articles/article-cover-images/2020/08_thecaseforasianhighyield_fivereasonstoinvest_737x480.jpg","custom_ss_authors":["80377"],"custom_ss_author_links":["/bio/lau-arthur-cfa"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"Discover four reasons why Asian high yield bonds continue to be a compelling stand-alone investment.","custom_s_local_url":"/en/investor-types/default/insights/asia-high-yield-four-reasons-to-consider-this-compelling-market","score":1.0},{"id":"174804","custom_i_asset_id":174804,"custom_s_title":"China Beyond Evergrande: Contagion or Containment?","custom_dt_date":"2021-09-24T00:00:00Z","custom_s_description":"The global spotlight is focused sharply on China right now. While the fallout from Evergrande’s looming credit event will be widely felt across global financial markets in the coming months, there is a bigger question confronting investors: what’s the future of China’s fixed income market?
\nEvergrande is not the first case of a debt debacle in China; earlier this year, China Huarong, a state-owned enterprise, needed a government bailout after a near-US$16 billion loss.1 However, the difference with Evergrande is twofold: first, it is more entrenched in the Chinese economy; and second, it is less likely to get direct government support.
\nDespite Evergrande's seemingly “too big to fail” scale, we expect Beijing to resolve the debt woes by prioritizing an orderly restructuring of the company, instead of offering direct support.
\nInevitably, there will be some financial pain for bondholders in the short term, coupled with dented confidence within the international investment community. Longer term, however, it shouldn’t deter investors from capitalizing on benefits such as yield and diversification that China fixed income can offer global portfolios – via selective exposure based on the right research.
\nThe unprecedented scale and complexity of the Evergrande situation will take its toll over the coming months.
\nUntil a more concrete government action plan emerges, we expect the company’s size and linkages within China’s economy to exert continued pressure on financial markets. A higher systemic risk premium will be built-in: what nobody knows is, just how much.
\nYet we believe authorities can and will intervene to prevent spillovers into the broader property market and, therefore, the wider financial system. This is based on our view that the government has sufficient policy tools to minimize the impact. It has demonstrated these in how it has handled a number of large-scale defaults (for example, Baoshang Bank, HNA, and China Fortune Land Group), controlling the associated contagion risks.
\n![\"Evergrande](\"/_assets/images/articles/charts/china-beyond-evergrande-chart-1.png\" "\\"Evergrande")
Source: Company report, CBIRC, PineBridge estimates as of 24 September 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts, and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
Looking more closely at Evergrande’s debt profile should provide some clarity – as well as reality – in terms of how it can be managed to avoid any long-term concerns among global investors.
\nFor example, the company’s total interest-bearing debts amount to approximately 0.36% of total banking system loans. And even if trade payables are included as debts, they account for less than 1% of the banking system’s loans. Also, a substantial portion of the onshore borrowings are backed by Evergrande’s property assets, which represent US$250 billion-plus value on its balance sheet.
\nAs a result, the actual credit loss for lenders will be even smaller than the above percentages. Further, with the banking system CET1 ratio at 10.5% and loan provision ratio at 3.4%, we think the loss associated with direct Evergrande exposure is very manageable, although some banks, such as smaller regional banks, may have relatively larger exposures to the company.
\nIn view of the potential deceleration of China’s housing market, we also believe that far-reaching fears about the extent of the direct exposure within China’s bank system to the property sector are overstated. As of first-half 2021, for instance, the banking sector had 27.4% of loan exposure to real estate (down from a peak of 29% at end-2019). This was split into 6.6% to developers and 20.7% to mortgages. Notably, the mortgage non-performing loan (NPL) ratio has stood at below 0.5% since 2010, and we believe asset quality will stay healthy. In addition, with the average loan-to-value (LTV) ratio being 40-50%, the market would need to see a sharp plunge in housing prices for home equity to turn negative. We see this as unlikely; maintaining price stability is the government’s policy objective given that 40% of loans use property assets as collateral.
\nIn a worst-case stress scenario, the NPL ratio would climb to 25% for developers (from <2% today) and 5% for mortgages (from <0.5%) currently), and assuming a loss-given-default (LGD) ratio of 50%, we estimate the CET1 ratio to drop from the current 10.5% to 8.6% (versus the regulatory minimum of 7.5%). To be clear, these default rate assumptions are not our base case expectation, but a hypothetical stress test.
\nWe would expect policy easing if there are signs of such a distress scenario materializing, considering the systemic importance of the sector in terms of direct and indirect GDP contribution.
\n![\"June](\"/_assets/images/articles/charts/china-beyond-evergrande-chart-2.png\" "\\"June")
Note: Stress Assumptions: Developer NPL ratio 25% vs. now <2%; Mortgage NPL ratio 5% vs. now <0.5%; Construction NPL ratio 5% vs. now <2%; LGD ratio 50%
\nSource: CBIRC, PineBridge estimates as of 24 September 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts, and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
![\"Banking](\"/_assets/images/articles/charts/china-beyond-evergrande-chart-3.png\" "\\"Banking")
Source: PBoC as of 30 June 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts, and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
![\"Banking](\"/_assets/images/articles/charts/china-beyond-evergrande-chart-4.png\" "\\"BBanking")
Source: CBIRC, PineBridge estimates as of 30 June 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts, and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
Based on our analysis, the onshore banking system can absorb the shock even under the worst-case scenario as shown above, which also suggests that a systematic crisis is unlikely to happen.
\nDomestically, a large-scale credit event would put pressure on the property sector, particularly for highly leveraged players and the lending banks.
\nIn the above worst-case scenario, real estate would be negatively impacted by significant declines in volume and prices in the physical property market from two key sources. First, it could trigger a fire-sale of Evergrande’s inventory, leading to significant downward pressure on housing prices. This, in turn, would suppress the profitability of its peers and reduce homeowner wealth. Second, the failure of Evergrande to deliver pre-sold housing units could lead to significant losses for homebuyers and a confidence crisis among other developers.
\nAs China’s largest property developer, Evergrande’s potential collapse also has a knock-on effect on numerous suppliers and its employees. This creates an ever more complicated resolution process with potential for unintended social issues and contagion risks.
\nIn line with this, we believe the worst-case scenario is unlikely given the potential social and economic disruption that would arise. Instead, a restructuring scenario is more likely, with protection for homebuyers and suppliers the top priority. Already, Evergrande is prohibited in several cities from selling property at prices deemed too low, due to concerns over unfair market competition. This reflects the focus of the authorities on maintaining market stability amid the policy tightening cycle.
\nMore broadly, investors can also reference recent incidents of financial distress involving large Chinese companies where the government has been involved in the resolution to prevent contagion.
\nEvergrande’s crisis should also not be a surprise. The credit tightening bias towards the Chinese property sector has been in place for some time; since 2018, developers have only been allowed to issue offshore bonds to refinance outstanding offshore debt. Recently, the “three red lines” policy was introduced, aiming to reduce overall leverage in the sector and at the company level. This policy has led to a fundamental divergence in the sector, with stronger names starting a deleveraging cycle while weaker ones faced liquidity pressure.
\nWhile many developers have subsequently accelerated asset disposals, property sales, and other measures to increase cash flow or pay down debts, the market dynamics have deteriorated more sharply than expected for the weakest names as the property market in China cools off. Besides Evergrande, a few property developers defaulted since the beginning of the year; however, at the same time, there are also property developers continuing to exhibit deleveraging trends.
\nWe believe policy relaxation is unlikely in the near term. It is still too early to call for the reversal of sector policy direction, given we are at the start of the deceleration and property sales activity in the past year was still elevated. We also believe today’s policy makers are more determined in cooling down the sector than those in the previous cycles. They appear to view control over the housing market as being of long-term national strategic importance as part of efforts to address issues such as low birth rates, systemic risk, credit allocation, and wealth inequality.
\nThat said, if the self-inflicted deceleration is faster than targeted and creates significant drag on the economy (given the contribution of the property sector to GDP), we think at the margin policies will be fine-tuned to contain the tail risks.
\nEvergrande’s US dollar-denominated bonds amount to approximately US$19 billion, or 5.5% of the JACI High Yield Index. As a result, the company’s current predicament has dragged performance of the asset class and will skew default rates. However, credit spreads in Asia high yield bonds – even if we exclude Evergrande – are pricing in close to a 10% implied default probability. This indicates significant fear of systemic risks.
\nIn our view, since we do not believe Evergrande will result in contagion, we see the market as being excessively bearish.
\nIn particular, the recent cases of high-profile defaults in China underscore our long-held belief in the need for thorough, independent credit research in fixed income investing across all sectors and the overall market.
\nWe continue to see opportunities in the Chinese bond market, both onshore and offshore. However, with the potential for more defaults, we cannot overemphasize the need to get credit analysis right, instead of relying on external credit ratings or hard-to-quantify implicit government support as the basis for an investment.
\nWe also believe current rating methodologies of international and onshore credit rating agencies need to be revised to better reflect intrinsic credit risk domestically. It is positive to see recent central government initiatives to develop credit approaches in the onshore credit rating process, as they should help improve the quality of credit ratings.
\nIn short, as China continues to undergo policy and market reforms and pushes forward market liberalization, including foreign access to onshore capital markets, international investors should consider partnering with asset managers that have a strong on-the-ground capability to help navigate this complex yet potentially alpha-rich market.
\n1 Please see “China Huarong announces state bailout alongside $16bn loss,” Nikkei Asia, 19 August 2021: https://asia.nikkei.com/Business/Markets/China-debt-crunch/China-Huarong-announces-state-bailout-alongside-16bn-loss
\nInvesting involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"China Beyond Evergrande: Contagion or Containment?","custom_s_image":"/_assets/images/articles/article-cover-images/2021/09-china-beyond-evergrande.jpg","custom_ss_authors":["80377","80526","153868"],"custom_ss_author_links":["/bio/lau-arthur-cfa","/bio/suen-andy","/bio/zhang-fan"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"Despite Evergrande’s seemingly “too big to fail” scale, we expect Beijing to resolve the debt woes by prioritizing an orderly restructuring of the company, instead of offering direct support.","custom_s_local_url":"/en/investor-types/default/insights/china-beyond-evergrande-contagion-or-containment","score":1.0},{"id":"174645","custom_i_asset_id":174645,"custom_s_title":"China’s Evergrande: A Fortress Made of Sand?","custom_dt_date":"2021-09-21T00:00:00Z","custom_s_description":"The global spotlight is focused sharply on China right now. While the fallout from Evergrande’s looming credit event will be widely felt across global financial markets in the coming months, there is a bigger question confronting investors: what’s the future of China’s fixed income market?
\nEvergrande is not the first case of a debt debacle in China; earlier this year, China Huarong, a state-owned enterprise needed a government bailout after a near-US$16 billion loss1. However, the difference with Evergrande is two-fold: firstly, it is more entrenched in the Chinese economy; and secondly, it is less likely to get direct government support.
\nDespite its seemingly “too big to fail” scale, we expect Beijing to resolve the debt woes by prioritizing an orderly restructuring of the company, instead of offering direct support.
\nInevitably, there will be some financial pain for bondholders in the short term, coupled with dented confidence within the international investment community. Longer term, however, it shouldn’t deter investors from capitalizing on benefits such as yield and diversification that China fixed income can offer global portfolios – via selective exposure based on the right research.
\nThe unprecedented scale and complexity of the Evergrande situation will take its toll over the coming months.
\nUntil a more concrete government action plan emerges, we expect the company’s size and linkages within China’s economy to exert continued pressure on financial markets. A higher systemic risk premium will be built-in – what nobody knows is: just how much.
\nYet, we believe authorities can and will intervene to prevent spillovers into the broader property market and, therefore, the wider financial system. This is based on our view that the government has sufficient policy tools to minimize the impact. It has demonstrated these in how it has handled a number of large-scale defaults (for example, Baoshang Bank, HNA and China Fortune Land Group), controlling the associated contagion risks.
\nSource: [xxx] as of [xxx]. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts, and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
Looking more closely at Evergrande’s debt profile should provide some clarity – as well as reality – in terms of how it can be managed to avoid any long-term concerns among global investors.
\nFor example, the company’s total interest-bearing debts amount to approximately 0.36% of total banking system loans. And even if trade payables are included as debts, they account for less than 1% of the banking system’s loans. Also, a substantial portion of the onshore borrowings are backed by Evergrande’s property assets, which represent US$250 billion-plus value on its balance sheet.
\nAs a result, the actual credit loss for lenders will be even smaller than the above percentages. Further, with banking system CET1 ratio at 10.5% and loan provision ratio at 3.4%, we think the loss associated with direct Evergrande exposure is very manageable, although some banks, such as smaller regional banks, may have relatively larger exposures to the company.
\nIn view of the potential deceleration of China’s housing market, we also believe that far-reaching fears about the extent of the direct exposure within China’s bank system to the property sector are overstated. As of 1H21, for instance, the banking sector had 27.4% of loan exposure to real estate (down from a peak of 29% at end-2019). This was split into 6.6% to developers and 20.7% to mortgages. Notably the mortgage non-performing loan (NPL) ratio has stood at below 0.5% since 2010 and we believe asset quality will stay healthy. In addition, with the average loan-to-value (LTV) ratio being 40-50%, the market would need to see a a sharp plunge in housing prices for home equity to turn negative. We see this as unlikely; maintaining price stability is the government’s policy objective that 40% of loans use property assets as collateral.
\nIn a worst-case stress scenario, the NPL ratio would climb to 25% for developers (from <2% today) and 5% for mortgages (from <0.5%) currently), and assuming a loss-given-default (LGD) ratio of 50%, we estimate the CET1 ratio to drop from the current 10.5% to 8.6% (versus the regulatory minimum of 7.5%). To be clear, these default rate assumptions are not our base case expectation, but a hypothetical stress test.
\nWe would expect policy easing if there are signs of such a distress scenario materializing, considering the systemic importance of the sector in terms of direct and indirect GDP contribution.
\nSource: [xxx] as of [xxx]. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts, and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
Source: [xxx] as of [xxx]. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts, and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
Source: [xxx] as of [xxx]. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, estimates, forecasts, and forward-looking statements presented herein are valid only as of the date of this presentation and are subject to change.
Based on our analysis, the onshore banking system can absorb the shock even under the worst-case scenario as shown above, which also suggests that a systematic crisis is unlikely to happen.
\nDomestically, a large-scale credit event would put pressure on the property sector, particularly for highly leveraged players and the lending banks.
\nIn the above worst-case scenario, real estate would be negatively impacted by significant declines in volume and prices in the physical property market from two key sources. Firstly, it could trigger a fire-sale of Evergrande’s inventory, leading to significant downward pressure on housing prices. This, in turn, would suppress the profitability of its peers and reduce homeowner wealth. Secondly, the failure of Evergrande to deliver pre-sold housing units could lead to significant losses for homebuyers and a confidence crisis among other developers.
\nAs China’s largest property developer, Evergrande’s potential collapse also has a knock-on effect on numerous suppliers and its employees. This creates an ever more complicated resolution process with potential for unintended social issues and contagion risks.
\nIn line with this, we believe the worst-case scenario is unlikely given the potential social and economic disruption that would arise. Instead, a restructuring scenario is more likely with protection for homebuyers and suppliers the top priority. Already, Evergrande is prohibited in several cities from selling property at prices deemed too low, due to concerns over unfair market competition. This reflects the focus of the authorities’ on maintaining market stability amid the policy tightening cycle.
\nMore broadly, investors can also reference recent incidents of financial distress involving large Chinese companies where the government has been involvement in the resolution to prevent contagion.
\nEvergrande’s crisis should also not be a surprise. The credit tightening bias towards the Chinese property sector has been in place for some time; since 2018, developers have only been allowed to issue offshore bonds to refinance outstanding offshore debt. Recently, the “three red lines” policy was introduced, aiming to reduce overall leverage in the sector and at the company level. This policy has led to a fundamental divergence in the sector with stronger names starting a deleveraging cycle while weaker ones faced liquidity pressure.
\nEvergrande’s crisis should also not be a surprise. The credit tightening bias towards the Chinese property sector has been in place for some time; since 2018, developers have only been allowed to issue offshore bonds to refinance outstanding offshore debt. Recently, the “three red lines” policy was introduced, aiming to reduce overall leverage in the sector and at the company level. This policy has led to a fundamental divergence in the sector with stronger names starting a deleveraging cycle while weaker ones faced liquidity pressure.
\nWhile many developers have subsequently accelerated asset disposals, property sales, and other measures to increase cash flow or pay down debts, the market dynamics have deteriorated more sharply than expected for the weakest names as the property market in China cools off. Besides Evergrande, a few property developers defaulted since the beginning of the year; however, at the same time, there are also property developers continuing to exhibit deleveraging trends.
\nWe believe policy relaxation is unlikely in the near term. It is still too early to call for the reversal of sector policy direction, given we are at the start of the deceleration and property sales activity in the past year were still elevated. We also believe today’s policy makers are more determined in cooling down the sector than those in the previous cycles. They appear to view control over the housing market as being of long-term national strategic importance as part of efforts to address issues such as low birth rates, systemic risk, credit allocation, and wealth inequality.
\nThat said, if the self-inflicted deceleration is faster than targeted and creates significant drag on the economy (given the contribution of the property sector to GDP), we think at the margin policies will be fine-tuned to contain the tail risks.
\nEvergrande’s US dollar-denominated bonds amount to approximately US$19 billion or 5.5% of the JACI High Yield Index. As a result, the company’s current predicament has dragged performance of the asset class and will skew default rates. However, credit spreads in Asia high yield bonds – even if we exclude Evergrande – are pricing in close to a 10% implied default probability. This indicates significant fear of systemic risks.
\nIn our view, since we do not believe Evergrande will result in contagion, we see the market as being excessively bearish.
\nIn particular, the recent cases of high-profile defaults in China underscore our long-held belief in the need for thorough, independent credit research in fixed income investing across all sectors and the overall market.
\nWe continue to see opportunities in the Chinese bond market, both onshore and offshore. However, with the potential for more defaults, we cannot overemphasize the need to get credit analysis right, instead of relying on external credit ratings or hard-to-quantify implicit government support as the basis for an investment.
\nWe also believe current rating methodologies of international and onshore credit rating agencies need to be revised to better reflect intrinsic credit risk domestically. It is positive to see recent central government initiatives to develop credit approaches in the onshore credit rating process, as they should help improve the quality of credit ratings.
\nIn short, as China continues to undergo policy and market reforms and pushes forward market liberalization, including foreign access to onshore capital markets, international investors should consider partnering with asset managers that have a strong on-the-ground capability to help navigate this complex yet potentially alpha-rich market.
\nInvesting involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
","custom_s_image_alt":"TITLE","custom_s_image":"/_assets/images/articles/article-cover-images/2021/09-evergrande-2021.jpg","custom_ss_authors":["80377","80526","153868"],"custom_ss_author_links":["/bio/lau-arthur-cfa","/bio/suen-andy","/bio/zhang-fan"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"The fallout of China Evergrande’s imminent credit event will be felt far and wide across the global financial markets for months to come and is likely raise questions about investing in China’s fixed income market.","custom_s_local_url":"/en/investor-types/default/insights/china-evergrande-a-fortress-made-of-sand","score":1.0},{"id":"174537","custom_i_asset_id":174537,"custom_s_title":"Leveraged Finance Asset Allocation Insights: Bank Loans Beckon Amid Retail Flows and CLO Demand","custom_dt_date":"2021-09-20T00:00:00Z","custom_s_description":"Spreads on high yield bonds and bank loans continued to tighten in September. Energy-related credits performed well as oil prices remained above $70 a barrel and natural gas hit seven-year highs. Volatility has been concentrated in China, where the highly indebted real estate developer Evergrande caused market flutters, as did a regulatory overhaul by the Chinese government that could lead to greater oversight of gaming companies operating in Macau.
\nOutside of these areas, investors have seen a steady grind tighter from most segments of the leveraged finance market. Demand for credit remains robust despite investor concerns related to the impact of the Delta Covid variant, the potential for fading quantitative easing (QE) stimulus from the Fed and other central banks, less enthusiastic corporate and GDP growth outlooks, and the potential for higher corporate taxes in the US.
\nAs we look ahead, despite tight valuations, we remain constructive on credit in general and leveraged finance asset classes in particular. While GDP forecasts have declined to about 3%, down from 6.6% in the second quarter, growth remains strong enough to provide a positive fundamental backdrop for the bank loan and high yield markets. Over the next 12 months we expect to see minimal default losses from most sectors.
\nIn terms of relative value, we maintain a slight preference for bank loans vis-à-vis high yield bonds, as the former continue to benefit from a supportive technical backdrop given retail inflows and steady collateralized loan obligation (CLO) demand. Nonetheless, we continue to find attractive opportunities at the issuer level in both markets.
\nThe following sections reflect the investment team’s views on the relative attractiveness of the various segments of below-investment-grade corporate credit. Conviction scores are assigned on a scale from 1 to 5, with 1 being the highest conviction.
\nKevin Wolfson
Portfolio Manager,
US Leveraged Loans
CS 2.8 (unchanged)
\nFundamentals: Loan issuers reported strong second-quarter earnings, with many companies posting double-digit year-over-year (y/y) gains; some issuers are even seeing improvements relative to 2019 comps. Near-term input cost headwinds remain a concern, but many issuers have been able to mitigate the impact of higher material and labor costs. The semiconductor shortage continues to weigh on certain sectors, including automotive and hardware-focused technology. Leverage ratios and interest coverage for issuers continue to improve, driven by higher EBITDA, relatively low Libor rates, and declining spreads. The last-12-month (LTM) default rate by amount outstanding for the S&P/LSTA Leveraged Loan Index continues to decline, ending August at 0.47%. Expectations are for defaults to remain below 1% over the near to medium term.
\nValuations: Spreads tightened over the last month. The spread-to-maturity for the S&P/LSTA Leveraged Loan Index went from Libor+408 as of 17 August to L+399 as of 14 September. CCC rated loans saw the largest movement, tightening roughly 25 basis points (bps) over the same period, while BBs and single-Bs came in 8 bps and 5 bps, respectively. The weighted average bid of the market increased approximately 44 bps month-over-month and now stands at 98.53 as of 14 September. CCC rated and liquid loans saw the largest gains in average price, moving up 69 bps and 51 bps, respectively. Loans appear fairly valued on a risk-adjusted basis at current levels.
\nTechnicals: Demand for loans remains strong on the back of record-breaking CLO issuance in August and the continuation of positive retail fund flows. Despite the strong demand, the market experienced a supply surplus last month, driven by leveraged buyout (LBO)-fueled issuance. Notwithstanding a short reprieve in supply around the US Labor Day holiday, loan issuance has started to reaccelerate, driven by mergers and acquisitions (M&A) and refinancing activity. Similar to recent trends, new-issue supply remains heavily weighted to the single-B rating category. Overall, supply/demand technicals remain fairly in balance.
\nJohn Yovanovic, CFA
Head of High Yield
Portfolio Management
CS 3.0 (+0.2)
\nFundamentals: Looking through next quarter into 2022, sales and earnings estimates for S&P 500 and high-yield (HY) equities are in the high single-digits, which is more in line with the long-term trend than the volatility seen over the past six quarters. Where 2021 was the year of early-cycle fundamentals versus late-cycle valuations, 2022 is looking to be a year of mid-cycle fundamentals. Bank of America Merrill Lynch models agree with Bloomberg estimates, with improvement in fundamentals expected to slow to more normal levels. With so many defaults in 2020, the 2021 LTM default rate is surprising to the downside at 1.14% (JP Morgan as of 31 August). The still positive, flattening trend should see more differentiation by sector going forward.
\nValuations: As rates markets get more confidence in the Fed’s base case, buyers are returning to fixed-rate credit. Rising prices plus minor increases in US Treasury yields are driving Bloomberg US Corporate High Yield Index spreads back to the tight end of their recent range, with option-adjusted spreads (OAS) now at 280 (as of 15 September), near the 270-300 OAS target of our spread model. Spreads are fair near term, and we continue to see merit as the asset class remains attractive relative to the other options. Our spread model continues to suggest 4%-5% annual returns (PineBridge Investments calculations as of 15 September). Carry remains king. BB/B credit continues to be favored, and first-time issuers continue to provide value opportunities.
\nTechnicals: Primary issuance remains heavy and has picked back up as expected. We’ve already seen 36 deals for $17.7 billion priced through 15 September, which puts the market on pace to meet or exceed the September average (JP Morgan Securities). Fund flows have returned at the margin but aren’t dominant. JPM and BAML continue to forecast an increase in net supply that is being accommodated by both retail and institutional flows, leading to continued growth of the universe. The steady new-issue calendar and range-bound spreads lead to neutral technical conditions, with sharp downside moves in specific issuers or volatility events possible.
\nLaila Kollmorgen, CFA
Portfolio Manager, CLO Tranche
CS 2.6 (unchanged)
\nFundamentals: CLO fundamentals, in general, remain good across all metrics. With lower anticipated defaults in the US combined with active management and good credit selection, we anticipate CLO fundamentals to improve.
\nValuations: BBBs are at 240-425, BBs at 515-725, and Bs at 700- 1,000. BBB rated CLOs are fair value compared to HY OAS (280) and to BB rated leveraged loans (300). BB rated CLOs are trading wide of single-B HY at 325 and leveraged loans at 425 on an OAS basis. The three-month cross-currency Japan yen/US dollar basis is approximately -8 bps as of 14 September, almost unchanged over the month, with longer-term cross-currency hedges also roughly unchanged. US dollar assets remain attractive when hedged on any term. (Valuations based on Bloomberg and S&P/ LCD data as of 14 September.)
\nTechnicals: Demand remains and continues to support spreads. We had anticipated heavy levels of supply in September and see that continuing in the next few months.
\nEvangeline Lim
Portfolio Manager,
European Leveraged Finance
CS 2.7 (unchanged)
\nFundamentals: The euro-area economy recorded another marked expansion in business activity during August, with momentum down slightly from July’s 15-year peak. Jobs growth continued at one of the fastest rates seen in over 20 years. Issuers across most sectors have reported strong improvement in operating results due to a combination of factors, including demand/top-line recovery and efficient cost management.
\nValuations: So far, the new-issue spread remains at levels seen in July. Loans continue to look attractive.
\nTechnicals: Despite the anticipation of a robust new-issuance pipeline post-summer, few loan investors were motivated to sell assets in August to raise cash for the new deals. So far, the pace of new issuance has been slower than anticipated. There have been a few BWICs (bids wanted in competition), but they have had very limited to no impact on secondary loan prices.
\nEvangeline Lim
Portfolio Manager,
European Leveraged Finance
CS 3.0 (+0.2)
\nFundamentals: The euro-area economy recorded another marked expansion in business activity during August, with momentum down slightly from July’s 15-year peak. Jobs growth continued at one of the fastest rates seen in over 20 years. Issuers across most sectors have reported strong improvement in operating results due to a combination of factors, including demand/top-line recovery and efficient cost management.
\nValuations: Valuations looks fair due to the low default environment, improving fundamental outlook, and an expected continuation of accommodative monetary policy versus the US.
\nTechnicals: Technicals have been supported by the slower-than-anticipated pace of post-summer new issuance. Cash available for deployment appears to have been slightly augmented by trickling inflows.
\nLaila Kollmorgen, CFA
Portfolio Manager, CLO Tranche
CS 3.0 (+0.4)
\nFundamentals: As in the US, European CLO fundamentals remain good month-over-month. Active CLO management combined with good credit selection continue to show up in positive tailwinds for CLO fundamentals.
\nValuations: BBBs are at 275-425, BBs at 575-825, and single-Bs at 750-935. BBB rated CLOs are fair value to BB rated HY and leveraged loans, while BB rated CLOs are cheap to European HY and leveraged loan single-Bs. European CLOs benefit from a Euribor floor of zero, which adds about 55 bps to their yield. The current euro/US dollar three-month swap, at about -3 bps, means that while European and US BBB/BB/B CLOs might be similar on a spread basis, the benefit of the Euribor floor highlights the relative value of European CLO tranches. That said, secondary market comparisons are very deal-specific. (Valuations based on Bloomberg and S&P/LCD data as of 14 September.)
\nTechnicals: Similar to the US, primary supply looks to be higher in the next few months. In contrast to the US, the size of the European investor base is smaller, and we could see spreads widening on the back of heavy supply.
\nSteven Cook
Co-Head of Emerging
Markets Fixed Income
CS 2.5 (unchanged)
\nFundamentals: We left our scores unchanged given the positive skew in credit trajectories. Of the 306 companies within our coverage that have reported second-quarter/first-half numbers, nearly three times as many have a positive six-month credit outlook as those with a negative outlook. The main change over the month is the increase in default expectations with the inclusion of Evergrande, whose pending default is the main reason JP Morgan moved its full-year 2021 default expectations from 2.4% to 5.5%. Ex-China, the full-year default rate is expected to be 1.8% (JP Morgan as of 13 September).
\nValuations: We maintain our valuations scores, as the spread-to-worst on the CEMBI BD Index has tightened slightly (-9 bps) over the last month to 251 bps but is virtually flat quarter-to-date. HY continues to slightly outperform investment grade (IG), although in China over the last month IG has tightened 25 bps while HY widened by 78 bps. We retain a bullish longer-term score given the spread pickup on offer versus other asset classes. (JP Morgan as of 14 September.)
\nTechnicals: Issuance picked up this month with $21 billion in supply month-to-date (MTD), and year-to-date (YTD) issuance of $402 billion is up 12% y/y. The new issuance this month is being well digested given higher cash levels, which we expect to continue. Of the MTD supply, 75% has been IG (versus 63% YTD), but we expect HY issuance to pick up. We retain our bullish score based on continuing inflows to the sector, including new allocations to the asset class (JP Morgan as of 13 September).
\nLeveraged Finance Asset Allocation Insights is a monthly publication that brings together cross-sector views within our leveraged finance fixed income group. Our global team of investment professionals convenes in a live forum to evaluate, debate, and establish top-down guidance for the asset classes that make up the leveraged finance investment universe. Using our independent analysis and research, organized by our fundamentals, valuations, and technicals framework, we take the pulse of each segment of the leveraged finance market.
\nThe information presented herein is for illustrative purposes only, represents a general assessment of the markets at a specific time, and is not a guarantee of future performance results or market movement. It does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; or a recommendation for any investment product or strategy. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. PineBridge Investments does not approve of or endorse any republication of this material. In addition, the views expressed may not be reflected in the strategies and products that PineBridge offers.
","custom_s_image_alt":"Leveraged Finance Asset Allocation Insights: Bank Loans Beckon Amid Retail Flows and CLO Demand","custom_s_image":"/_assets/images/articles/article-cover-images/2021/09-sep-lfaai-2021.jpg","custom_ss_authors":["80188"],"custom_ss_author_links":["/bio/oh-steven"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"We remain constructive on leveraged finance asset classes with a preference for bank loans, which stand to benefit from a supportive technical backdrop. And while valuations remain tight across credit markets, we continue to find attractive opportunities at the issuer level across both high yield and loans. ","custom_s_local_url":"/en/investor-types/default/insights/leveraged-finance-asset-allocation-insights-bank-loans-beckon-amid-retail-flows-and-clo-demand","score":1.0},{"id":"174270","custom_i_asset_id":174270,"custom_s_title":"What is Driving Credit Markets?","custom_dt_date":"2021-09-20T00:00:00Z","custom_s_description":"\n\n\n\n
We discuss the latest macro developments moving credit markets and assess investment opportunities (and headwinds) for this large, complex asset class.
\nHosted by Aurelia Sax, deputy head of client services, EMEA.
","custom_s_image_alt":"What is Driving Credit Markets?","custom_s_image":"/_assets/images/articles/article-cover-images/2021/09_2021_stevenoh_podcast.jpg","custom_ss_authors":["80188"],"custom_ss_author_links":["/bio/oh-steven"],"custom_s_doc_type":"Article","custom_s_asset_type":"Fixed Income","custom_s_meta_description":"We discuss the latest macro developments moving credit markets and assess investment opportunities (and headwinds) for this large, complex asset class.","custom_s_local_url":"/en/investor-types/default/insights/what-is-driving-credit-markets","score":1.0}]}}