Core Opportunities in Asia High-Quality Income
By Arthur Lau - Managing Director, Co-Head of Emerging Markets & Head of Asia ex-Japan, Fixed Income, Global Emerging Markets Fixed Income, PineBridge Investments, Hong Kong AND Omar Slim - Senior Vice President, Fixed Income, Global Emerging Markets Fixed Income PineBridge Investments, Singapore
Asia remains a main driver of global growth, with increasing economic and financial clout. Rapid Asian capital developments – and the corresponding impressive investment gain potential – offer new sources of portfolio return and risk translating into new beta and alpha opportunities.
Nowhere is this more apparent than in Asia’s investment grade fixed income markets. While current headline risk may elevate market volatility toward the end of the year, favorable technicals and fundamentals continue to indicate that the segment offers attractive long-term investment potential, particularly as investors prepare fixed income allocations for the increasing wind down of accommodative central bank monetary policies worldwide.
Although Chinese issuers continue to make up the bulk of Asia’s investment grade credit markets, it is important to remember that the broader region represents a collection of large, incredibly diverse economies. Our outlook on several major markets is highlighted below.
China: 19th National Congress to anchor China’s economic stability
The most significant near-term focus for the Asian bond market is the new Chinese government which will be unveiled in October at the 19th National Congress of the Communist Party. We expect announcements underlining the ongoing gradual steps China has been taking to liberalize its capital markets, rein in leverage and reform its state owned enterprises (SOEs).
We continue to see value in China, particularly within some SOEs, and select real estate and large financial issuers. Further strategic SOE consolidation and merger and acquisition activity is expected to continue, which should generally lead to increased investment grade credit supply to the US dollar market. These new consolidated companies will maintain their investment grade ratings, given their government ownership and strategic positioning.
Korea: Strong fundamentals amidst rising tensions
Tensions radiating from North Korea have substantially increased and will remain an overhang over Korean assets, including Korean credit. However, market reaction has so far been mild, and South Korean bonds do look attractive on a selective basis. Putting political noise aside, several interesting new deals have offered attractive spreads relative to historical levels. However, given their elevated risk premium, many Korean issuers have had to tap the local market, rather than the US dollar market, for funding.
In our view, this risk premium is predominately due to the geopolitical tensions rather than fundamentals. When strictly considering the macro numbers, South Korea has no major issues. There are pockets of risk to be monitored, such as in the consumption and mortgage sectors, but other sectors, such as manufacturing, continue to perform remarkably well.
Southeast Asia: Positive credit momentum and rebounding trade
Southeast Asia is one of the few areas that witnessed positive credit ratings momentum in the past five years. The Philippines, for instance, went from below investment grade five years ago to investment grade by all three major rating agencies today. Indonesia also witnessed a substantial credit rating improvement, with three major agencies rating it investment grade earlier this year. In addition, with trade on the rebound, monetary policy still accommodative, and inflation in check, Southeast Asian economies are doing well. We are surgical in our issuer selection and aware of the relatively tight valuations, favoring some Indonesian exposure as well as select names in the commodity space.
A well-anchored asset class
Positive factors continue to strengthen the case for Asia’s investment grade credit securities. What was a relatively small and niche market only a decade ago has expanded considerably in both size and appeal.
Since 2009, the overall Asian credit market has more than tripled in value. This steady growth has helped increase liquidity and illustrates consistently growing investor demand to access the potential offered by the region’s fixed income market, of which approximately 80% is represented by investment grade credits.
Asia’s gross credit issuance are expected to reach record highs in 2017, with more than US$200 billion estimated to come to market year to date. However, taking into account the more than US$135 billion in maturing bonds and coupon payments, net issuance is actually much lower. This limited supply, coupled with increasing demand for Asia’s favorable bond yields, particularly for higher credit quality investment grade securities, is driving stronger technicals for the asset class. Moreover, Asian investors are now the dominant buyers of these credits, holding 81% of market assets. This helps explain the lower volatility the asset class has been experiencing, as domestic buyers investing in their home markets in companies they know and understand, often tend to be “stickier” in nature.
Fundamentals across the region also remain steady, and improving in some pockets. For example, corporate leverage – particularly in China – has been a primary area of concern. However, looking across broader Asia, net leverage for investment grade issuers has remained relatively steady after moving lower post the 2008 economic crisis. In contrast, net leverage for issuers across other major global regions have markedly increased over the past several years, with broader Asian debt ratios now 26% lower than other emerging markets, 30% lower than EMEA, 40% lower than the US, and 53% lower than Latin America. While there are certainly areas of excess leverage in the region, as a whole it appears that Asian issuers are generally well positioned to support current debt levels, even should markets turn volatile.
We continue to see solid opportunities in Asia’s investment grade bond market. Given some of the current uncertainties, investors interested in the region are likely best served with an active manager. This universe of securities can be quite complex, and strong on-the-ground research capabilities and a demonstrated ability to navigate both the region’s opportunities and potential pitfalls can be crucial in unlocking the full additive potential of this attractive – and quickly growing – market.
For reference only. Investment involves risks. The value of investments therefrom may fall as well as rise. Investors may lose all or part of the investment capital. We are not soliciting or recommending any action based on this material. This material is issued by PineBridge Investments Asia Limited and has not been reviewed by the Securities and Futures Commission (SFC).