21 June 2021

2021 Midyear Asia Fixed Income Outlook: Fundamentals Trump Fears

  • In the next several months, the region’s recovery and containment of Covid-19, global policy direction, and China’s normalization track will likely be the key factors influencing the Asian investment grade (IG) market.
  • Our base case scenario in Asian IG is for spreads to remain well anchored, with a tightening bias.
  • Within the Asian high yield universe, we continue to find attractive opportunities in Chinese property debt in terms of yield and duration.
  • The first half of the year saw a very strong market for green, social, sustainability, and sustainability-linked bond issuance. We expect this trend to continue for the rest of the year, reflecting both increased ESG awareness in Asia and the growing pool of capital focused on ESG-linked strategies.
Asia Fixed Income Midyear Outlook: Fundamentals Trump Fears

The resurgence of Covid-19 in some parts of Asia and recent volatility in global bond markets have not shaken the strong fundamentals that anchor Asian fixed income. Asian bonds continue to offer attractive yield, diversification benefits, and protective characteristics against potential rising rates, underscoring our long-held conviction that the asset class warrants greater exposure than what global benchmarks have to offer.

With Asia experiencing an uneven recovery, we expect significant dispersion in returns across industries, markets, and issuers going forward. Inflation fears and policy normalization in China and the US may bring potential episodic volatility, but we believe active credit selection, along with duration and curve positioning, should help investors position defensively as well as realize alpha opportunities.

Asian investment grade

Rising US Treasury yields have constrained the performance of the Asian hard-currency investment grade market in recent months. Although we view this trend as in line with US policy normalization as economic conditions improve, we are cautious about duration risk. That said, Asian IG has, on average, shorter duration than US IG and Global Agg (at 2.47 years, compared to 3.87 years for US IG and 7.18 years for Global Agg), offering a buffer against interest rate hikes.1 Coupled with Asian IG’s higher risk-adjusted returns over other asset classes, the case for high quality Asian bonds as a diversifier remains robust.

Asian IG Offers Better Risk-Adjusted Returns Relative to Other Asset Classes

5-Year Total Return History

Asian IG Offers Better Risk-Adjusted Returns Relative to Other Asset Classes

Source: Bloomberg. Rolling 5 year data as of 31 March 2021.Commodities represented by the Bloomberg Commodity Index, Asia USD Bonds by the JPM JACI index, Asia IG USD Bonds by JPM JACI Investment Grade, Emerging Markets (USD) by the JPM EMBI Global Diversified index, US Inflation Linked by Bloomberg Barclays US Inflation Linked index, US Equities by S&P 500 index, Asia ex Japan Equities by the MSCI MXASJ index, UK Gilt Inflation Linked by S&P U.K. Gilt Inflation-Linked Bond Total Return Index, UK IG Corporate Bond by S&P U.K. Investment Grade Corporate Bond Index Total Return, and UK Gilt by Bloomberg Barclays Sterling Gilt Total Return Index. Diversification does not insure against market loss. For illustrative purposes only. We are not soliciting or recommending any action based on this material. 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, or any prediction, projection, or forecast, is not indicative of future performance.1 Volatility is a statistical measure of the dispersion of returns for a given security or market index. In most cases, the higher the volatility, the riskier the security. 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 the next several months, the region’s recovery and containment of Covid-19, global policy direction, and China’s normalization track will likely be the key factors influencing the Asian IG market. Our base case scenario is for spreads to remain well anchored, with a tightening bias. On duration, the team expects to see some consolidation at current levels, although the bias should continue to be for higher yields. The region’s credit fundamentals remain robust, and fallen angel risk at approximately 3.5% is relatively low, with the highest risk seen among India and Macau issuers, reflective of challenging economic conditions in these two markets.

Asian Fallen Angel Risk Is Manageable

Asian Fallen Angel Risk Is Manageable

Source: JPM, PineBridge Investments as of January 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, forecasts, and forward-looking statements presented above are valid only as of the date indicated and are subject to change.

Asian high yield

Asian high yield rallied in the first half on the back of a commodities rebound and positive sovereign developments (particularly for Sri Lanka after the government secured a loan from China to shore up its financial position). We expect credit spreads to have a tightening bias on the back of stable and improving fundamentals.

Within the Asian high yield universe, we continue to find attractive opportunities in Chinese property debt in terms of yield and duration. With a potential tightening in China on the horizon, we prefer higher quality issuers that have a strong national franchise. 

Select Chinese Property High Yield Offers Attractive Returns

Select Chinese Property High Yield Offers Attractive Returns

Source: BofA as of 20 April 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any views represent the opinion of the manager and are subject to change.

Asian high yield remains one of the most attractive segments in emerging markets debt. Valuations are attractive versus long-term averages and durations are shorter compared to US high yield (at 2.47 years for Asia high yield versus 3.87 years for US high yield2). More importantly, on the back of an improving economic outlook, we do not expect a spike in the default rate, and investors should be well compensated by credit spreads. Excluding two heavy index weight constituents, the default rate in the JACI HY index is expected to be 2.7% by notional value and 1.8% by market value in 2021. Within our expected 2.7% default expectation, over half of the defaults would come from China, mainly in cyclical sectors such as real estate, transport, and consumer. By sector, metals and mining accounts for 31% of the expected default, with a concentration in Indonesia and India.

Asia HY Default Rate Remains Well Compensated by Credit Spread

Asia HY Default Rate Remains Well Compensated by Credit Spread

Source: JPMorgan, PineBridge Investments as of 14 April 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, forecasts, and forward-looking statements presented above are valid only as of the date indicated and are subject to change.

China onshore and offshore markets

The debt debacle at China Huarong Asset Management, one of the largest distressed debt managers in the country, clouded the market given the dominance of Chinese issuers in Asian USD bonds. Huarong’s case may reshape the market infrastructure, such as market perception of government support and greater credit differentiation of Chinese government-owned sectors, and should further support the importance of credit selection and credit due diligence rather than reliance on credit ratings. (Please read our analysis, “Breaking Down China Huarong’s Debt Case.”)

In the onshore market, we favor central government-backed issuers that have strong standalone credit profiles over local government financing vehicles and other local government-backed entities. Central government bonds continue to offer higher yield than major developed market government bonds and have low correlations with them, offering diversification benefits for global investors.

On the policy front, China’s credit impulse appears to have peaked, and indications are that stimulus will slow down for the rest of the year. Policymakers face a balancing act between fast-rising GDP growth, higher purchasing managers prices, and muted consumer prices.

Growing interest in ESG bonds

The first half of the year saw a very strong market for green, social, sustainability, and sustainability-linked bond issuance, making up approximately 19% of all new issuances from Asia so far this year, led by green bonds.3 We expect this trend to continue for the rest of the year, reflecting both increased ESG awareness in Asia and the growing pool of capital focused on ESG-linked investment strategies.

Relative to other regions, Asia’s green/sustainability bond market is still relatively small, and we have yet to see its full potential. China is key to supply, given the government’s target of carbon neutrality by 2060. China’s goal is expected to create huge demand for green financing across multiple areas of the economy (for example, Chinese property issuers) in the next several years, thus deepening the domestic Chinese green bond market, which is already the biggest in Asia.

For now, we have yet to see a consistent green/ESG bond premium in Asia green bonds. Investors 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, transparency, and credit ratings.

Overall, we believe Asian fixed income’s characteristics offer opportunities for superior risk-adjusted returns for the yield starved. However, careful credit selection with attention to duration should be the focus to avoid risks around inflation and rising rates. A growing regional institutional base that tends to be less reactive to external shocks and healthy credit fundamentals (such as high interest rate coverage and better corporate earnings across the market) should continue to anchor the market, cushioning the impact of global volatility. Strong on-the-ground research capabilities and a demonstrated ability to navigate both the region’s opportunities and potential pitfalls should help in unlocking the full additive potential of this fast-growing market.

For more insights into trends moving economies and markets, visit our 2021 Midyear Investment Outlook page.

Footnotes

1 Source: Bloomberg, PineBridge Investments as of 12 March 2021. Asian IG is represented by JACI Investment Grade, US IG by the Bloomberg Barclays US Credit Index, and Global Agg Credit IG by the Bloomberg Barclays Global Aggregate Index.
2 Source: Bloomberg, PineBridge Investments as of 12 March 2021. Asia HY is represented by JPM JACI Non-Investment Grade Index, US High Yield by Bloomberg Barclays US High Yield Index.
3 Source: JP Morgan as of 1 June 2021.


Disclosure

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.

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