Fixed income starts to get back on track
fixed income
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China’s bonds and real estate credit hit the ground running
Chapter one
Fund selectors reveal their cautious fixed income picks
Chapter two
After jumping hurdles in H1, investors hunt for yield
Chapter three
Slow and steady wins the race in emerging markets
Chapter four
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Wealth managers are continuing to recommend both high yield and investment-grade bonds in US and European credit markets, as well as Asian bonds that have proven to have stronger fundamentals in the emerging world. China’s hard currency and local currency bonds are looking attractive relative to other markets, with BB-rated Chinese property bonds expected to return more than 7% in the next six months. The fixed income market has been under stress in India. Reduced liquidity saw Franklin Templeton wind up six of its credit funds in the country in April, creating a sense of panic among debt investors. Some wealth managers are expecting to see more redemptions from many other credit funds in India, which will only worsen the situation. The ongoing pandemic has forced many fund managers to tweak their portfolios and adjust holdings in an effort to outperform the market. Examining specific market exposures, Vontobel has reduced weight in Indonesia, Brazil and the UAE, while adding to Mexico and higher-rated issuers in Saudi Arabia and Peru. First State is looking at higher quality names such as Abu Dhabi and Qatar, while in Asia, it is looking at the potential beneficiaries of changes to global supply chains, such as the Philippines and Indonesia. On the product shelf, a number of new fixed income products were launched during the pandemic. Fullerton Fund Management registered its Asian investment-grade bond in Singapore, while UBS launched an onshore fixed income fund in China. Hong Kong approved BEA Union Investment Management’s Asia Pacific bond fund and Foundation Asset Management’s China high yield income fund. And Ares Australia Management launched a new global credit income fund for investors down under.
audrey raj, editor, citywire asia
Running up that hill
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A running start
chapter one
As Asia begins to recover from the pandemic, the region’s asset classes hit the track, with Chinese bonds and real estate credit pegged as potential emerging winners. The Asian region is currently something of an anomaly. While talk of negative yields has become commonplace in certain parts of the world, things are different in Asia. The region was the first to begin exiting the Covid-19 pandemic, and, having learned from previous crises, most Asian governments and central banks have stronger balance sheets and are running more prudent fiscal and monetary policies, according to Daryl Liew, CIO of REYL Singapore. ‘The pandemic has definitely impacted domestic economics, but the strong policy response by central banks around the world to cut interest rates and the relatively low oil prices have provided Asian central banks with room to run supportive monetary policies,’ he said. ‘Hence the view on Asian fixed income has not been unduly disrupted by the crisis.’
by neil johnson
So perhaps the question that begs to be answered now is how long will this low-rate environment persist this time? Is it medium-long-term in lifespan or should we be mindful of a quicker recovery from this crisis? ‘The market is currently pricing in extremely low inflation for the foreseeable future, but there is a chance that the global economy bounces back faster than expected, fuelled by the wave of liquidity being pushed into the system,’ Liew said. ‘As such, it may be prudent to diversify fixed income portfolios with some protection for the scenario of rising inflation.’ In the lower-for-longer camp is Stephen Chang, an Asia-focused portfolio manager for Pimco in Hong Kong, who expects major central banks to keep official rates low and various asset purchase programmes to remain active. ‘In order to generate income, and with some comfort that a backstop such as the corporate credit facilities from the Federal Reserve to prevent further disruptive spread widening, we anticipate inflows into the credit market to continue even though spread levels in some markets have already retraced a good degree.’
There has been a stronger command of the public health aspect in China, and we anticipate a speedier recovery
Back in March, the market sold off heavily as it attempted to reflect the pandemic’s potential to disrupt, which included the risk of not being able to refinance easily in the bond market and a rise in default rates. However, with central bank support, the market has notably recovered, led by the US investment-grade segment, which is a direct beneficiary of liquidity facilities. Asia investment grade, on the other hand, has lagged and offers very decent spread pickup versus historical ranges. ‘Barring further disruptions, Asia high yield should see its spread compressed versus those in the US, as well as with a likely lower default rate from recovering macro fundamentals and for selective issuers,’ Chang said. ‘Bond supply could be an offsetting factor and issuance has been running at a brisk clip over the past seveal weeks.’ Indeed, Dilkes views the high yield market as a good way to tap the region’s fundamental long-term attractiveness, specifically because of attractive valuations. ‘Asian high yield spreads are currently close to levels last seen during the global financial crisis in 2008,’ he said. ‘This implies that valuations are attractive and a potentially good entry opportunity for investors. Despite improving sentiment, spreads have remained high relative to those in the US and Europe because Asian bonds have not been beneficiaries of uniform central bank purchases. Meanwhile, a normalisation of spreads over the next one to two years may offer potentially compelling returns.’ To this end, as well as China’s real estate, Dilkes currently favours India’s renewable energy sector. ‘Although India’s economy has gone through a rough patch in the last 12 months, there are several solar and wind energy companies with strong fundamentals,’ he said. ‘It’s important to note that the performance of these companies is not closely correlated with the broader economy in India. In fact, Indian high yield renewable energy names have performed well. While initially yields were lower relative to their Asian high yield peers, they were also more resilient.’ Fidelity International’s Lai and Chan also see Asia’s high yield and investment-grade bonds as promising plays in a low-interest-rate environment. Although, investors should be mindful of the volatility pick up and liquidity pressure in credit markets. ‘Asian and China high yield markets continue to offer attractive income opportunities, which tend to cushion total return amid volatility,’ the pair said. ‘Yet, liquidity management would be especially critical in investing in high yield markets during a volatile market. Meanwhile, valuations of Asia investment-grade bonds remain attractive relative to peers, they said. ‘High-quality credits like Asia investment-grade bonds with attractive risk premia should be well-positioned for investors to navigate the uncertainties.’ However, credit selection will remain vital as they expect credit differentiation to continue, with access to funding remaining challenging for weaker corporates.
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Chang is cautiously optimistic on Asia fixed income, with the potential of further spikes of the virus and lockdowns anchoring his outlook. ‘This has significant implications for the macroeconomic outlook and the resulting monetary and fiscal policies each country is pursuing,’ he said. ‘In the case of China, there has been a stronger command of the public health aspect, and we anticipate a speedier recovery as recent data has corroborated. This will lead to stronger asset market performance in both equities and credit spreads, while monetary actions can be less aggressive.’ Ross Dilkes, portfolio manager in Asia fixed income at UBS Asset Management, agreed: ‘The People’s Bank of China (PBoC) has kept enough monetary policy powder dry to be well-positioned to spur its economy – either through fiscal or monetary policies – should it need to. The PBoC has taken a cautious approach to fiscal and monetary policy relative to other countries. To date, the size and scope of the stimulus have not matched that which occurred after the 2008 financial crisis.’ Meanwhile, on the corporate credit front, investors are constructive towards China’s property sector, which is backed by a favourable policy stance. ‘We continue to have bias towards high-quality and large-scale developers, as we expect to see continuous sector consolidation where quality developers are in a better position to take advantage of better funding access and explore land opportunity with the control of leverage ratios,’ said Fidelity International’s Giselle Lai, associate investment director, and Vanessa Chan, investment director. Dilkes is also a fan of larger developers and favours the residential segment over commercial real estate, given the latter’s exposure to unfavourable rental revisions after the fall-off in business activity amid the outbreak. ‘In China, demand for housing has returned and this has pushed up prices,’ he said. ‘Our preference is for large, leading property developers. These companies have more diverse funding options, which can be useful in times of scarce liquidity.’
Stephen Chang, Pimco
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Staying on track
chapter two
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We have seen a rebalancing of the portfolio as a result of the correction in March. Investors who had raised cash to meet margin calls – or to de-risk – are rebuilding the portfolio, starting with the allocation to fixed income especially in investment-grade bonds. At the current moment, we are neutral on Asian IG bonds in the short term due to sanction risks. However, for investors with an investment horizon longer than six months, Asia investment-grade and high yield bonds can deliver attractive returns. Amid the low to negative yields that now persist in the US and other developed markets, investors will look to Asia for higher yields. Overall, in Asia, new issuance activities continue to pick up and Asian bond spreads are still wider than pre-March drawdown and may offer potential capital gain from future spread compression. There are a handful of levers to pull when seeking for higher yields. The first lever is looking at high yield bonds. We want to be selective as defaults may likely pick up due to the lockdown measures in containing the spread of Covid-19 affecting the viability of certain industries and businesses. Extending the duration is the second lever to seek higher yields when rates are expected to stay low for longer. In emerging markets, there are other levers, such as looking at corporate bonds in addition to sovereign bonds as another attractive source of yield and even in local currency bonds when the US dollar may have peaked. If we shift gear to the non-traditional space, securitized assets are an alternate source of attractive yield and will likely be a popular choice among investors seeking higher yield. I look at fixed income fund managers that are able to flexibly pull the various levers to achieve attractive yields without causing an ‘overheating’ of the engine by taking on excessive or concentrated risk in any of these areas. Selective use of leverage is the additional ‘grease’ to oil the engine and enhance yields, especially when the US dollar borrowing cost is lower than it was at the start of the year.
The Fed has expressed interest in keeping interest rates near zero through 2022, making the hunt for yield more acute than ever. Are you looking to increase your allocation to fixed income? If so, what fixed income asset classes have captured your attention and what are the factors are you looking most closely at in this dovish environment?
Serene Ang Senior fund specialist Credit Suisse Private Banking Asia Pacific / Singapore
The demand for fixed income assets will be further underscored by the search for cash alternatives in the prevailing low interest rate environment. With money market yields at historical lows, shorter duration bond funds will find favour for those looking to pick up some yield. Within the overall spectrum of fixed income investments, with the economic recovery likely to be uneven across sectors and geographies, there are both opportunities and risks going forward and it is important to be selective. Active management and diversification will help mitigate some of the risks. While credit markets have recovered well post the March sell-off, on the back of supportive actions from the US Federal Reserve and ECB, sectors such as Asian hard currency bonds still offer opportunity for investors with longer investment horizons. Multi-sector strategies with flexibility to look at the best prevailing opportunities will also be suitable in an uncertain economic environment.
Rishabh Saksena Head of investment specialists, Asia Julius Baer / Singapore
G10 central banks have made it clear that policy rates will remain on the floor until the end of 2022. The Fed’s median projections that the federal funds rate will stay near zero until the end of 2022 will effectively lock the two-year US Treasury yield. We expect it is unlikely that the yield curve will steepen too much due to subdued growth expectations. We expect US 10-year Treasury yield will trade towards 0.5% at the end of this year and modestly rebound to 1% at the end of 2021. The low-yield environment is supportive for carry assets, backing our overweight allocation to global and US investment-grade credit, emerging markets and Asian hard currency bonds. We recently upgraded our view on European investment-grade and high yield bonds to neutral from underweight due to reduced tail risk in the eurozone with support of the Next Generation EU recovery plan. In the global search for yield, we see attractive carry opportunities in Asian hard currency bonds which offer a good risk-return trade-off. Asian corporate bonds have relatively strong credit fundamentals and offer a substantial yield pickup over developed markets bonds of the same credit ratings. In the Asian credit market, we stay overweight Chinese hard currency and local currency bonds due to their attractive yield pickup and strong policy stimulus drivers. We favour Chinese property developers, including selective Chinese property high yield bonds, as property transactions have shown increasing signs of recovery since April.
Fan Cheuk Wan Chief market strategist, Asia HSBC Private Banking / hong kong
Our multi-asset discretionary portfolios are positioned with an overweight to fixed income and we feel comfortable keeping allocation at this level. We like high yield and added to it as early as March when spreads were at around 1000bps. We have started seeing some deceleration after the fastest month on high yield issuance in June. Spread volatility is likely to increase this year with new data on the virus and the US election cycle. We have room to add to this sector but we would want to see a sizable increase in spreads to add as the default rate will continue to be relatively high. To enhance carry, the valuation for emerging market debt (EMD) is relatively attractive, which could be an option for consideration. We are neutral on EMD partly due to the bifurcation of high- and low-quality assets in the sector. The relatively attractive spread is driven by the below-investment-grade part of the index, which includes a few countries that need debt restructuring. The health impact of Covid-19 is likely to hit emerging market countries harder and we find it difficult to predict the outcomes and, therefore, are keeping an eye on the emerging markets closely, although we do not foresee inflations or implementation of tighter monetary policy in the near term. Duration looks interesting if and when US 10-year grinds higher.
Yvonne Leung Executive Director, Senior Portfolio Specialist J.P. Morgan Private Bank, Asia / hong kong
Jumping the hurdle
chapter three
‘It is understandable that most institutional investors are positioned quite cautiously, especially given the elevated levels of uncertainty, challenging fundamentals and stretched valuations. However, technicals seem to remain ascendant and, unless there is a sufficient catalyst to promote a risk-off move in markets, it strikes us that fear may give way to greed in the next few weeks. Until the point when the market is over-extended, leading to a deeper correction.’ For Adam Whiteley of Insight Investment, fund manager of the BNY Mellon Global Credit fund, the crisis is challenging broadly held investing assumptions. ‘We’ve been shocked by the pace of the moves in both directions. We began the year seeing a cyclical outlook for economies that was fairly benign. And we were positioned accordingly. We’ve obviously had to completely reappraise those assumptions. ‘Thinking about the world today in any sort of conventional sense becomes quite challenging, because you will find very few textbooks that talk to shocks of this order, that have severely affected both the demand and the supply side. You’ll find very few textbooks that will tell you about how to deal with unconventional monetary policy, let alone when you have an economic shock on this level.’ There will definitely be lasting scars, he continued. ‘For example, within the high yield space, because of the policy response and the amount of forbearance, the peak in default rates will probably have been lower than you would otherwise expect. But you would also expect there to be quite a long lag in default rates remaining elevated. ‘On the government bond side, you’re going to need yields to remain very low for the foreseeable future, because you need low interest servicing costs for all this debt that’s been accumulated. One way that governments can potentially make that debt servicing more attractive is by letting inflation run a little bit hotter, so how central banks deal with that will be interesting.’
Thinking about the world today in a conventional sense is quite challenging
‘The hunt for yield is in full swing,’ said Jan Bopp, senior investment strategist at Bank J. Safra Sarasin. This is not a sentiment we would have expected from investors at the beginning of the year. ‘Going into January, we were positioned for a global reflation,’ said David F. Hoffman, managing director and portfolio manager at Brandywine Global. ‘Broad-based central bank easing around the world was expected to benefit local economies. With US-China trade tensions easing, helped by the phase one trade deal, conditions were supportive for global growth.’ And then the coronavirus crisis. Almost in the blink of an eye, the global economy lurched violently into recession. ‘The pandemic became a black swan event,’ Hoffman continued. ‘This exogenous shock – truly different from previous crises – created a medically driven collapse in demand as the government-directed policies tackling the disease also depressed consumption. ‘The fiscal and monetary responses we have seen have been breathtaking in scope, but the impact of these policies might take longer to filter down to the economy as they cannot boost overall demand until the virus subsides.’ Meanwhile, Mark Dowding, CIO at BlueBay Asset Management, noted a side effect of abundant liquidity. There is a sense that technicals dominate fundamentals, which can lead investors to voice the opinion that ‘fundamentals don’t matter anymore’, which is a worry, he said. ‘We may yet hear more comments along these lines, in a world where central banks appear set to deliver de-facto yield curve control, with interest rates stuck at (or below) zero for some years to come, However, there is also a sense that this feels highly complacent.
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As Bank J. Safra Sarasin’s Bopp pointed out, these are strange times indeed when a country like Austria can issue a 100-year government bond with a yield of less than one percent. ‘What was unthinkable in the past is now reality. What was even more astonishing was that the bond was 10 times oversubscribed. Rates at record lows and a low-growth environment pushes investors to pay higher and higher premiums for yield and growth, wherever they can find them. Although we think interest rates are unlikely to rise meaningfully any time soon, it still pays off to do a thorough due diligence as the selection will mainly drive the return of the portfolio.’ Brandywine’s investment process hinges on the expectation that when a negative macroeconomic experience drives asset prices to pessimistic extremes, the resulting price dislocations and policy response ultimately create the conditions for macro stabilisation and a mean-reversion opportunity. ‘Given low real yields in developed markets and an increasingly high price risk where government bonds are trading at a significant premium to their intrinsic value, we prefer higher-yielding segments of the market that have supportive macroeconomic conditions and catalysts for mean-reversion,’ Hoffman said. ‘These segments include select emerging market and peripheral European sovereigns and high-quality investment grade credit. However, while we favour these segments of the global bond market, we are also mindful of the significant uncertainty and potential for volatility in the current environment and have been maintaining exposure to US Treasurys as risk-off ballast.’
It might not be a straightforward time to be an investor – whether equities or fixed income, globally-focused or otherwise – but price dislocation and well-selected valuations offer scope for diversification, which is critical in these times. ‘Despite already sharp declines in credit spreads, we remain overweight in investment-grade, emerging market and high yield bonds,’ Bopp said. ‘Valuations in these segments continue to be more attractive than in equities and still offer a positive diversification benefit. In addition, the potential for setbacks is limited due to the extensive asset purchase programmes of central banks. This applies in particular to investment-grade bonds. ‘But the risk/return profile of emerging market and high yield bonds is more attractive, especially in the long term. And while a few data points may not make a trend, the Secondary Market Corporate Credit Facility’s flow of purchases suggests the US Federal Reserve’s portfolio may be quite small relative to the facility’s maximum capacity. So the Fed’s backstop should continue to boost performance.’ On the other hand, Brandywine is constructive on US investment-grade bonds, specifically due to the Fed’s backstop, with Hoffman noting the many high-quality issuers coming to market. ‘We participated in several deals in the primary market and added a number of attractively priced, high-quality US investment-grade names.’ On the lower-quality end of the spectrum, he feels the Fed could lend additional support, especially if economic activity once again comes to a standstill, volatility in commodity prices reemerges or second quarter earnings register well below market expectations. ‘Investors may already be anticipating additional central bank support as US high yield new issuance continued to substantially increase month-over-month in June.’ Lastly, Robert Almeida, global investment strategist at MFS Investment Management, highlighted that while the Covid-19 crisis has exposed and worsened the fragile and stretched balance sheets of some companies, a concerning anomaly appears to have occurred. ‘When debt is raised to replace lost income rather than fund productive projects, balance sheets weaken,’ he said. ‘Yet, despite the weakening of the average balance sheet, risk premia have fallen. Companies with negative working capital and terminally challenged business models are the most at risk and the most inappropriately valued. Offering attractive risk profiles are those with high barriers to entry, unique intellectual property or a “build it once, sell it many times” model. These are assets worth owning.’
Adam Whiteley, Insight Investment
Slow and steady
chapter four
As to allocation, Overfelt feels that in such periods of uncertainty, diversification and liquidity are key, which has led him to downsize the average position and increase the number of names in the portfolio, while volatility also creates bottom-up opportunities. ‘We have shifted to higher-quality names, including via those rare primary issues that, in our view, still have value left after the book-building process,’ he said. ‘We also reduced exposure to certain energy names, more out of risk management considerations, even if we are still positive on oil prices. We also continue to trade airline bonds, still mindful of potential risks, so with a large degree of diversification within the sector.’ Regarding specific market exposures, Vontobel has reduced weight in Indonesia (mainly high yield), Brazil and the UAE, while adding to Mexico and higher-rated issuers in Saudi Arabia and Peru. Going back to how trends have been affected by Covid-19, May sites social unrest in Latin America as an example of the crisis temporarily obfuscating a trend while ultimately exacerbating it. ‘Social distancing and lockdown measures have slowed this process down, but its root cause hasn’t gone away. Over time, we think this will lead to an increase of political and socioeconomic risk and hence we carefully rotate into other EM regions,’ he said. ‘In the Middle East, First State is looking at higher quality names such as Abu Dhabi and Qatar, while in Asia, [it is looking] at the potential beneficiaries of changes to global supply chains (away from China), like the Philippines and Indonesia.’
Among the investors Citywire spoke to, there appears to be a consensus towards higher-quality names, which naturally benefits investment grade. ‘We have a bias towards the more liquid and higher quality names,’ First State Investments’ May said. ‘Most of the investment-grade countries – or at least those we think will keep their investment-grade rating – can handle the economic fallout of the pandemic politically and economically.’ Nevertheless, the high yield segment of EM still presents some excellent opportunities, he continued, while highlighting how differentiation is of utmost importance – mind the gap! ‘Price levels have to be justified by each country’s underlying fundamentals to avoid any nasty surprises.’ Flying the flag for an active approach to credit analysis in differentiating winners from losers in the recovery, Wouter Van Overfelt, head of emerging market corporates and senior portfolio manager at Vontobel Asset Management, advocates high yield, given that investment-grade spreads have become a touch pricey. ‘In an ultra-low yield environment where Treasury yields have room to go a bit higher, we feel that low investment-grade spreads mean that this segment of the market has become a “duration +” play,’ he said. ‘The spreads give limited cushion for the duration risk, in other words. Thus, we continue to prefer high yield given wider spreads and broad opportunity set thanks to the lack of dedicated investors in the space and mispricings, which haven’t yet been ironed out in the recent rally.’
In such a landscape, Syed Razif Al-Idid, head of CIMB Private Banking in Singapore, is suggesting investors stay defensive and diversified. ‘A diversified portfolio helps mitigate high volatility and reduces correlation, concentration, credit and interest rate risks. A key risk is that the Federal Reserve has clearly stated its aversion to a negative interest rate due to its dislocation and disruptive effects on financial markets. The US policy rate is close to zero now, hence any further upside in corporate bonds would come from credit spread compression. However, we are cautious that bond markets could turn weaker in the short term if significant additional fiscal stimulus is introduced and corporate failures rise.’ CIMB, therefore, currently holds a neutral stance on bonds, underpinned by a continuation of soft monetary policies. However, widespread corporate failures and debt defaults are signalled by the sudden and unprecedented spike in corporate bond spreads in both investment grade and high yield bonds in March. ‘Smaller corporates are more prone to default risk, with high yield bonds expected to see default rates of 10%,’ Al-Idid said. ‘Meanwhile, default rates for investment-grade bonds will likely be more manageable (less than 1%). The spike in actual debt default rates may be mitigated and delayed by various monetary and fiscal measures.’ Unsurprisingly then, CIMB currently prefers investment-grade bonds. ‘The emphasis on quality and resilient corporate bonds is to prepare for higher default rates on lower-quality bonds during a recession,’ Al-Idid said. ‘Bond markets will post stronger performance if central banks cut rates further due to a weaker growth outlook, lower inflation or when severe financial crisis and market corrections occur.’
Investing in emerging markets (EM) rarely follows a linear or predictable narrative, but, given the size and diversity of the investible universe, it’s safe to say that emerging from the Covid-19 pandemic will not be plain sailing. ‘Some countries are in a better position to deal with the adverse economic effects of the pandemic than others,’ said Jan-Markus May, portfolio manager in fixed income and multi-asset solutions at First State Investments. ‘However, the hunt for yield has led to a wave of almost indiscriminate buying of EM bonds. Liquidity provided by the major central banks has lifted all boats and the price recovery happened nearly as quickly as the selloff in March. ‘We think that the market will start to differentiate more in terms of country-specific fundamentals, debt levels and risk premium. The crisis has indeed changed some elements of our outlook, but most trends that we have identified at the end of last year are still in place – some have slowed since the outbreak of the virus, while others have intensified.’ The speed and magnitude of the pandemic-induced selloff were of historic proportion, and while investors wait for a sustained recovery to take shape, there is one theme that has become apparent, according to Polina Kurdyavko, head of emerging markets debt at BlueBay Asset Management: price dislocation. ‘This has been driven by investors holding back in the sovereign market as they wait to understand the path of governments over the next 12 months. Corporates fared better given the broad spread of geographies that make up the EM universe – many “postcodes” can result in a more diverse opportunity set, especially in Asia, where Chinese real estate names delivered. ‘With a W-shaped recovery looking more likely for EM than the classical V-shaped rebound, volatility and dislocation are likely to become a market mainstay for some time. We believe that now more than ever is the time for unconstrained thinking – when we don’t know where the next surprise “winner” is going to come from, or indeed the next invisible threat, ability and adaptability seem like the order of the day.’
Social distancing and lockdown measures have slowed [social unrest] down, but its root cause hasn’t gone away
Jan-Markus May, First State Investments
For Kurdyavko at BlueBay, regionally speaking, she too sees red flags in Latin America, with the IMF forecasting the region to experience one of the deepest economic contractions in 2020, while the Asia Pacific region will generally experience a somewhat more muted adverse impact. Elsewhere, she expects African sovereigns to experience relatively high dispersion, ranging from weak, commodity-dependent credits such as Zambia to stronger ones such as Kenya, she said. ‘We anticipate oil-producing countries and regions, such as Sub-Saharan Africa, will experience higher stress if oil prices remain low over an extended period, while low commodity prices typically help commodity importing economies such as Turkey. The benefits, however, will be muted this time, as lockdowns and declines in external demand weigh heavily on the outlook for many companies.’
Environmental, Social, and Governance factors in EMD: integration and exclusion
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Taking into account Environmental, Social and Governance factors is paramount to gauging sovereign creditworthiness, even more so in emerging markets. Creditworthiness can be split between an issuer’s ability and willingness to service and repay debt. In relation to sovereigns, willingness to pay is intimately related to issues of governance. Ability to pay is greatly influenced by a country’s long term growth potential, and the probability of achieving it. We believe that these in turn depend on the way countries access and utilise all the forms of capital available to them - social, human and natural capital in particular, in addition to economic capital.
words By Magda Branet, Deputy Head of Emerging Markets Debt, and Kroum Sourov, Lead ESG Analyst
The human factor Let’s consider one of the four forms of capital as an example, the human capital, which is of the essence when it comes to broadening the camp of resources available to an economy. Human capital development through a quality education system allows a country to generate and absorb new technology, as well as to diversify its sources of income. Healthcare is very important from a growth perspective, as it helps minimise the amount of sick days within the workforce, and thus increases productivity. The importance of the interaction between natural and human capital has come to the forefront with the ongoing coronavirus pandemic. Generally, clean natural environment acts to both retain the high quality workers that the country produces, as well as to help ensure that the workforce stays healthy and productive. During the pandemic, this link has become even more vital. The leading international organisations such as the WHO and the UN are unanimous that pandemics are driven by human activities destroying natural habitat and thus facilitating transmission of viruses from wild animals to domesticated ones and ultimately to humans. Furthermore, long-term exposure to air pollution has been linked to a higher fatality rates from COVID-19. Even without taking the global COVID pandemic into account, according to the WHO air pollution is responsible for more than 7 million deaths on average each year globally, and in some developing countries pollution is to blame for as much as a quarter of all deaths.
Countries’ governance and sovereign risk Another key risk highlighted by ESG factors is related to governance and it is particularly topical in the context of emerging economies. The importance of identifying the potential misallocation of state resources through corruption, lack of accountability or mismanagement of public institutions is widely accepted in sovereign analysis and in our assessment of the social capital of a country. Much of those problems can stem from the type of government that is in charge. From the investors’ perspective, it is acknowledged that democratic accountability helps the social and economic systems function more efficiently by minimising wasteful practices. Candriam’s sustainability approach goes beyond the pure traditional governance considerations and looks at a broader range of factors, including socio-economic, that impact a country’s long term development. For instance, economic and gender inequality has the effect of starving the economy of consumer purchasing power. Excessive concentration of wealth can impede a healthy middle class, which is the engine of growth in healthy well-diversified economies. According to the IMF, resolving the gender gap in Pakistan and India could add up to 59% to their economic welfare, and up to 21% in the Middle East and North Africa.
Environmentally conscious Environmental protection may seem like a preoccupation mainly of the rich developed nations it is vitally important to the economic growth of developing nations. Many emerging market economies still rely on natural resources as their main growth driver, and sustainably managing their natural capital is key to maintaining their long term growth capabilities. Furthermore, developing countries are at the forefront of climate related risks, whose impact on GDP can be significant for small, non-diversified economies. A very encouraging example of international cooperation between advanced and developing economies are the five-country negotiations towards a climate trade deal between New Zealand, Norway, Costa Rica, Fiji, and Iceland that were announced in September 2019. The agreement is designed to remove tariffs on environmental goods such as solar panels or wind turbines, curb fossil fuel subsidies and encourage eco-labelling schemes.
1. "Coronavirus is a warning to us to mend our broken relationship with nature" on The Guardian
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2. "The link between air pollution and COVID-19 deaths" on World Economic Forum
3. World Health Organization databases
4. "Global pollution kills 9m a year and threatens 'survival of human societies" on The Guardian
or "The Lancet Commission on pollution and health"
5. IMF Staff Discussion Note - “Economic Gains from Gender Inclusion”, J. D. Ostry et al., October 2018
Investors as gatekeepers Investors in emerging market debt have two main tools at their disposal to take account of ESG factors. Exclusion during issue selection helps avoid some extreme risks, while Integration helps determine whether the return compensates investors for their risks. For example, exclusion can be invaluable in avoiding serious deviations from the UN Sustainable Development Goals (SDGs) that could have a significant impact on a country’s creditworthiness. On the other hand, integration ensures that investors are aware and compensated for risks. Considering sustainability factors allows for more realistic pricing of risks that are not accounted for by purely "crunching fiscal numbers". We believe the optimal approach is to combine the two.
6. "New Zealand leading trade agreement driving action on climate change and the environment" on the New Zealand Government
7. "Time to ACCTS? Five countries announce new initiative on trade and climate change" on IISD
Important Disclosure This document is provided for information purposes only, it does not constitute an offer to buy or sell financial instruments, nor does it represent an investment recommendation or confirm any kind of transaction, except where expressly agreed. Although Candriam selects carefully the data and sources within this document, errors or omissions cannot be excluded a priori. Candriam cannot be held liable for any direct or indirect losses as a result of the use of this document. The intellectual property rights of Candriam must be respected at all times, contents of this document may not be reproduced without prior written approval. Candriam consistently recommends investors to consult via our website www.candriam.com the key information document, prospectus, and all other relevant information prior to investing in one of our funds, including the net asset value (“NAV) of the funds. This information is available either in English or in local languages for each country where the fund’s marketing is approved.
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Strengthening ESG risk assessment through dynamic credit analysis
Investors increasingly recognise the benefits of ESG risk analysis in protecting the long-term value of their investments. As investment managers look to assess ESG risks, inadequate ESG disclosures, inconsistent definitions, diverse and often subjective interpretations imply that there are no short cuts to this process. We cannot merely rely on external ESG evaluation; active fixed income managers with significant credit research capabilities would be able to better understand the ESG risks of issuers and add value to investors. Investors are starting to appreciate that focusing on Environmental, Social and Governance (ESG) factors help reduce their exposure to long term risks. Increasingly, regulations, such as more stringent emission standards and heavier penalties for violations of environmental standards have raised the materiality of ESG risks to issuers. According to a survey conducted by the CFA Institute, investors expect environmental and social factors to have a greater impact on credit spreads and government bond yields going forward. See Fig. 1.
by Goh Rong Ren, Portfolio Manager, Fixed Income Eastspring Investments, Singapore
Research has shown that higher ESG ratings correlate with lower credit spreads, and issuers with good ESG track records tend to benefit during periods of flight to quality. A study by Bank of America Merrill Lynch shows that 73% of Asia Pacific companies which were downgraded between December 2009 – 2018 had below median ESG scores. Higher ESG scores, however, did not correlate with upgrades. This suggests that the consideration of ESG factors can help mitigate credit risks. The lower long-term risks resulting from an ESG-focused investment approach can be seen from Fig 2. The JACI ESG indexes, especially the JACI ESG high yield index, have lower volatility while delivering returns that are comparable to the broader bond indexes. MSCI also found that companies with high or upgraded ESG ratings generally experienced lower volatility. ESG risk assessment – it’s complicated ESG risks may not be immediately apparent and could gestate over a longer time period. Research by MSCI suggests that governance factors tend to have a greater impact on profitability, idiosyncratic and systemic risks in the short term (1 year) as they are most directly linked to short term events and incident risks. Environmental and social factors, on the other hand, are more important over longer periods. Not only do time horizons impact ESG factors, there are also sectoral differences to consider. Governance factors, for example, may matter more for the financial sector while environmental factors may be more critical for the materials and energy sectors.
As such, careful analysis is required to identify companies that are undergoing structural changes and assess their ability as well as readiness to adapt to such changes. By understanding the long-term viability of an issuer’s business model, active managers like ourselves can potentially avoid downside risks and protect the value of the portfolio’s underlying investments over the long run. ESG risk evaluation often goes beyond assessing a set of numbers but instead requires evaluating myriad “soft” and sometimes subjective factors. ESG factors are expansive and diverse, which makes them almost impossible to distill into a single number or rating that indicates “good” or “bad”. For example, how should one assess the environmental impact of a nuclear power plant or a hydro-electric dam? Such grey areas have led us to devise innovative ways to assess the corresponding risks and apply them in a consistent manner across our investment framework. The challenge in evaluating ESG risks can be seen from the fact that even ESG rating providers have different ESG ratings for the same company. Fig. 3 shows that while really “good” and “bad” ESG performers may be obvious, there is often greater subjectivity in rating companies that fall in-between.
No short cuts As such, we believe that there are no short cuts in ESG evaluation. This is particularly so in Asia with its inconsistent ESG standards and inadequate ESG disclosures. See Fig. 4. In fact, China only recently removed clean coal projects from its list of green bond financing targets, in order to bring some of its ESG parameters up to par with global standards. The lack of alignment between disclosure regimes across different jurisdictions also makes cross-country comparisons difficult. While many governments and institutions have pushed for greater ESG-related disclosures, Bloomberg’s ESG Disclosure Score Index (which ranks the usefulness of a firm’s disclosure information) gives the median company across 17 countries a score below 50%. We believe that active fixed income managers add significant value through their in-depth research of companies and understanding of ESG issues. At Eastspring, we do not simply rely on external ratings and assessments but draw on the strengths of our large credit research team. Their experience and depth of knowledge of the issuers help us make more informed decisions. While credit worthiness is a key pre-requisite, all securities and issuers are subject to an additional set of ESG risk evaluation criteria. We have formally incorporated corporate governance, historically an important factor in evaluating issuer risks, into our proprietary ESG evaluation framework. We also do not automatically exclude issuers in controversial industries. Instead we prefer to assess the effort that such companies are making to remain relevant and whether they may be effecting positive changes within their industries during the process. Some coal-powered operators, for example, are transiting to renewable sources of energy. We acknowledge these positive initiatives and may keep such issuers within our portfolios. We believe that active engagement with investee companies goes a long way to improve ESG practice and management.
An evolving journey A comprehensive ESG risk assessment will remain challenging until we achieve better quality ESG disclosures and greater consensus within the industry of what ESG means (ie a common taxonomy). While companies are already making progress on this front, thanks to the numerous international, regional and national initiatives, active fixed income managers that have significant credit research capabilities would be able to better understand the ESG risks of issuers and add value to investors. As the market evolves, we continue to refine our ESG framework with our learnings. We aim to embed our ESG framework across all our fixed income strategies as we seek to deliver sustainable long-term performance for investors. At Eastspring, we believe that we will make the best possible investment decisions on behalf of our clients by integrating material environmental, social and governance (ESG) factors into our investment processes. As a firm, we started on our Responsible Investing journey in 2014 when we became a signatory to the Japan Stewardship code. Since then, we have become a signatory to the United Nations-supported Principles for Responsible Investment (PRI), various stewardship codes across Asia and are members of the Asia Corporate Governance Network, International Corporate Governance Network, Climate Bond Initiative and more recently, joined the Climate Action 100+ network. Our shared purpose - Experts in Asia. Invested in Your Future. - places Responsible Investment at the very core of our business. As stewards of our clients’ capital, a sustainable future must be considered when investing for their long-term needs. We are not just focused on investing, but also ‘invested in’ and are committed to a sustainable future.
1. By Standard & Poor.
2. MSCI. Foundations of ESG Investing. How ESG Affects Equity Valuation, Risk, and Performance. Guido Giese, Linda-Eling Lee, Dimitris Melas, Zoltán Nagy, and Laura Nishikawa. July 2019.
3. MSCI. Deconstructing ESG Ratings Performance. Risk and Return for E, S and G by Time Horizon, Sector and Weighting. Guido Giese, Zoltan Nagy, Linda-Eling Lee. June 2020
4. Bloomberg. IIF. Includes companies listed in the benchmark stock exchanges in Indonesia, Thailand, Turkey, Korea, Brazil, US, Canada, South Africa, Europe, Hong Kong, Mexico, Singapore, India, Malaysia, Australia, China, Japan.
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HSBC Asian Fixed Income: Survival of the Fittest
Over the last few decades, Asian fixed income markets have seen a remarkable growth in assets, accompanied by transformative developments, particularly the increasing integration of China onshore markets into the global capital markets. Throughout this time, the performance of Asian dollar bonds has been on an upward trajectory and has comfortably exceeded the performance of global bonds over the past 20 years. Even when faced with market crises, Asian bonds have tended to recover sharply following a downfall. In the current COVID-19 situation, Asian dollar bonds stayed relatively resilient and experienced a smaller drawdown when compared to its global peers.
by Cecilia Chan CIO of Fixed Income, Asia-Pacific
As the managers of one of Asia's oldest credit funds, HSBC Global Asset Management has navigated various market cycles and weathered a number of crises. Our award winning Asian fixed income team continues to stay focused on maximizing return potential, as we have been doing for nearly 25 years.
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The new Taper Tantrum – H2 outlook 2020
The first half of this year saw one of the fastest and most aggressive market corrections in history, as Covid-19 spread around the globe. Just as unprecedented was the speed and extent of the subsequent recovery, thanks above all to governments and central banks having sent in the cavalry to boost liquidity and plug the consumer confidence gap. Combining fiscal and monetary stimulus, the global policy response is estimated to be $14 trillion and counting. With all this in mind, what’s next for global markets as we enter the second half of 2020 and beyond?
by JIM LEAVISS, cio of m&g public fixed income
The 2020 taper tantrum The second half will be all about the new Taper Tantrum. The first one was about the Fed’s balance sheet unwind, leading to a surge in US Treasury yields as the central bank announced the tapering of its quantitative easing (QE) programme in 2013. This one will be about the end of furlough schemes in developed markets. Countries are opening up again in order to limit economic damage, especially in the northern hemisphere where governments are keen to support growth through holiday spending. So far, the economic damage done to individuals has been cushioned to a large extent by furlough schemes, in which the government pays a large percentage of salaries for staff whom would otherwise have been laid off.
In the US, thanks to the CARES Act, the largest economic stimulus package in US history, we have a situation in which some workers have actually been better off being out of work than they were in their previous jobs. With direct payments to Americans and loans to business, the $2 trillion Bill amounts to 10% of US GDP, and is much larger than the $0.8 trillion Recovery Act of 2009. Adding together compensation of employees plus government unemployment benefits, we have the strange situation in which people in the US are receiving more income on average now than they were before Covid-19. This is a rather odd recession: they don’t normally send personal incomes soaring.
Fixed income
The danger is in the taper But what will happen when this stimulus begins to wind down? Government debt levels have exploded since March as tax receipts collapsed and unemployment costs rocketed. While there’s a lot of debate about whether this matters (see Eric Lonergan (of M&G) and Mark Blyth’s Angrynomics, which says that having negative sovereign interest rates makes this a time to invest in infrastructure), most governments want to start to taper assistance to the economy later this year. In the UK, this means that government furlough payments will be reduced in August and October, putting some of the wage burden back onto employers. What happens then? In anticipation of furloughs ending, UK retailers in particular have already announced mass redundancies. How many of the world’s furloughed workers don’t realise that they are actually unemployed? For this reason, plus the continued impact of Covid-19 on global travel and trade along with social distancing nervousness (however reduced from its peak), talk of a V-shaped recovery seems difficult to square with the environment we now face, despite low rates and some continued fiscal stimulus. It is likely that there will still be more fiscal stimulus and debt levels will continue to rise from here. How will we deal with them? The usual three options are: grow, inflate or default. The answer is basically the same sort of policies that allowed the UK to deleverage from 250% debt-to-GDP after the second world war. These included forms of financial repression like forcing high bank ownership of government bonds. In the US, it involved pinning bond yields to low levels – like we have seen in Japan since 2016, and in Australia in March this year. Such yield curve control (YCC) is already under active debate within the Fed (YCC is different from QE in that it targets a bond price or yield, rather than simply being a purchase of a set volume of bonds). Might we also see negative interest rates from the Bank of England (BoE) and the Fed? On a further slowdown, it is likely.
The return of inflation Does this make inflation more likely? The jury is out, and this largely depends on who wins the battle between labour and capital in the recovery. Labour has lost out for decades now. Will Covid-19 change that? The data so far are not promising: the latest research from the US Brooking Institute think tank says that it is the bottom 20% of wage earners that have suffered the highest unemployment rates, so hopes that we would emerge from the crisis wanting to reward low-paid key workers (nurses, delivery drivers, supermarket staff) might be dashed.
Received wisdom is that QE equals inflation. Is this true? The money supply expansion is huge – but so is the collapse of the velocity of money (i.e. the speed at which it circulates in the economy). Some argue that the most powerful effect of QE is that on a currency: as money is printed, the currency depreciates and inflation is generated through higher imported goods prices. But what if everyone is doing QE? What if everyone is trying to get their currency down? It has no impact. Positioning for the taper tantrum Credit We’ve come a long way since the lows of March, which offered some great opportunities to be overcompensated for default risk as a credit investor. Corporate bonds, which at their lows were pricing in investment grade and high yield default rates of 25% and 54% (23 March 2020), respectively, are now closer to fair value (pricing in 12% and 35% at 7 July 2020). Despite considerable volumes of issuance, high yield spreads have come a long way. It’s hard to get excited about credit valuations at these levels. There is still some value in investment grade: these companies are the big employers, so it is politically easy (and arguably a decent policy tool) to support them.
In Europe, the EU’s planned recovery fund and continued Pandemic Emergency Purchase Programme (PEPP) have been supportive. Flows are slowing as spreads are compressing, so demand is likely to shift to other high yielding sovereigns in the region that have been less aggressively bought so far by the European Central Bank (ECB) and investors. For this reason, I like bonds like 10-year Netherlands. Emerging markets One area in which I do see value is emerging market (EM) debt. Firstly, it offers higher real yields than developed market bonds. Also, EM currencies have lagged the recovery, meaning that some local currency bonds do offer attractive value (you can buy more per dollar). Emerging markets clearly face challenges due to Covid-19, particularly as a result of headwinds to global trade, but greater EM central bank intervention than we have seen before is helping and there are regional pockets of relative value. For example, I would expect Asia to outperform other EM regions, since high real rates make currencies here broadly attractive to investors. Additionally, many of these economies are net exporters and so this should also improve current account balances. Currencies We should see some mean reversion in valuations that moved aggressively in the first half. While EM local currencies looked fundamentally cheap across the board in the first half, going forward I expect to see some more moves based on fundamentals. I therefore anticipate rotating out of some of those currencies that have rallied aggressively (e.g., the Indonesian rupiah) to those where fiscal and central bank positions are strong, but valuations still look attractive (e.g., the Russian ruble). Unlike many EM local currencies, the dollar looks quite expensive on a fundamental basis. Despite this, I do own some dollar exposure, as it does its job in a ‘risk-off’ environment. On balance though, I prefer the Japanese yen for the better diversification and ‘risk-off’ hedge it offers. With the ECB having removed a lot of downside risk in the region through its aggressive buying programme, I also like holding the euro. It has become a very cyclical asset (rallying as sentiment improves, the opposite to the way the US dollar is behaving), so I hold it against the safe-haven currency of the region, the Swiss franc.
Short-term action, long-term impact The focus of financial markets moves quickly. We saw over the first half of 2020 just how quickly. After the deep and rapid panic-driven sell-off as Covid-19 spread around the globe, the extent to which asset prices have recovered reveals markets’ new focus: the unprecedented magnitude of fiscal and monetary stimulus. With millions of jobs lost in a few months, there is no doubt to my mind that it is this stimulus which is now driving markets: they are being driven by technical factors, not fundamentals. I think the focus may change just as rapidly in the second half, and it will be to the other side of the coin: what will markets make of the inevitable end of the monetary and fiscal bridge? Governments and central banks have, on the surface, succeeded in containing much of the financial fallout of the lockdown-driven drop in demand. The danger now is in the taper. How will we get out of all this debt? Grow? It seems implausible that trend growth will be higher in the aftermath of this crisis than before. Inflate? Central banks haven’t been able to achieve their inflation targets even in the good times, so what chance do they have of inflating away the debt now? Default? There’s no need to default if you can print your own currency – but we might see some debt jubilees (cancellation of student loans, for example), wealth taxes and confiscations, and even the cancellation of government bonds held by the central banks as part of QE. And what happens if the market stops believing that central banks are independent? Could that finally be the catalyst for inflation expectations to return to developed markets and, after decades of losing, will labour win over the power of capital this time round? The actions of a few months bring up these questions and more. We may have to wait for some years to learn the answers. Past performance is not a guide to future performance. The value and income from a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. The views expressed in this document should not be taken as a recommendation, advice or forecast.
Jim Leaviss began his career in financial markets in 1992. He joined M&G in 1997 and currently serves as CIO of M&G Public Fixed Income, where he heads a team that invests across investment grade and high yield credit, government debt and emerging markets debt.
The Fed’s support also begs the question, is it right that these companies survive? We have lost the creative power of destruction, where the old makes way for the new. Is capital really being allocated correctly and efficiently? We have seen how growth and productivity stagnates under these conditions in Asia at the end of the last century. Developed markets Despite the huge fiscal stimulus we have seen, it is difficult to be too bearish on government bonds now, given the yield-controlled world we live in. And bonds like bad news: while they are clearly very expensive, they do offer potential upside in the event that negative sentiment returns to markets in the second half. With inflation unlikely to rise significantly in the short term, I don’t mind owning duration.
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"They don’t normally send personal incomes soaring"
"What if everyone is doing QE? What if everyone is trying to get their currency down? It has no impact"
"They are being driven by technical factors, not fundamentals."
Asia’s Recovery: Possible Trajectories and Investment Opportunities
In early June, PIMCO’s investment professionals from around the globe gathered by video to discuss our latest Cyclical Outlook. Our baseline continues to be a bumpy and uneven recovery with pre-crisis level of economic activity unlikely to be reached before 2022 in most Western economies. In this Q&A, Asia portfolio manager Stephen Chang shares our thoughts on the path to recovery in Asia and the implications for investors in Asia credit. Q: While PIMCO believes a near-term mechanical bounce in global economic activity in response to the lifting or easing of lockdown measures looks likely, we expect the subsequent climb up to be long and arduous. How do we see the prospects for China? A: Growth in China’s June high frequency and manufacturing activity data indicates that the economy continues to recover from the effects of the coronavirus pandemic, supported by strong housing and infrastructure investment and normalization of consumption. This points to positive growth in second-quarter GDP overall. The recovery in Q2 has been driven by easing of lockdown measures, catching up on lost production, a surge in demand for medical products and online work equipment, and significant stimulus measures. On the macro policy front, the State Council, via the People’s Bank of China (PBOC) has cut the reserve requirement ratio (RRR), required banks to compress profits to help companies, promised to help small and medium banks raise capital, and pledged to lower lending rates and bond yields. China’s government has made it a clear priority to support lending to the real economy. So while there is some uncertainty around the relationship with the U.S., the data so far in China has recovered on pace and the trajectory is looking more promising.
words by Stephen Chang, Portfolio Manager, Asia
Q: Our latest Cyclical Outlook discusses how the key swing factor for the economic outlook lies outside economic or policy spheres. A rapidly evolving COVID-19 pandemic could easily push the global economy into better or worse trajectories than our baseline over our cyclical six- to 12-month horizon. What do the good and bad scenarios discussed in the cyclical outlook mean for APAC credit sectors? A: The good scenario is we have a more rapid economic recovery. This would happen if a vaccine or other medical treatments are developed with scalable results, reducing the need for social distancing faster than expected. In a V-shaped recovery, we favor certain domestic consumption sectors, for example China internet and China property, as well as companies that have a strong liquidity profile but which have underperformed year-to-date from sectors such as autos, ports and leasing. In this scenario, we would be less positive on sectors with limited upside in earnings and the potential for more significant spread tightening, such as banks and utilities. A bad economic scenario of a much slower recovery or even a double-dip recession would most likely result from strong and widespread second waves of COVID-19 infections that lead to renewed interruptions of economic activity. In an L-shaped recovery, some domestic consumption sectors would again benefit (particularly China internet & China property) given their strong market share and funding access. In addition, we would favor defensive sectors with high regulatory support and decent sponsors (banks, utilities, renewables and telecoms).
Q: Can you explain further why the China internet and China property sectors could outperform in both scenarios? A: China internet is a secular story and this sector will continue to be a beneficiary of the consumer adjustment to the impact of COVID-19, particularly in terms of working from home and online shopping. Apart from their business growth momentum, the financials remain solid for these internet companies and their equity share prices have stayed buoyant. This allows them to tap various funding channels as they expand and their relative valuations, compared with global internet peers, still look attractive. China property is a more domestically driven sector and hence less sensitive to global growth. Chinese policymakers would prefer to keep this important economic driver steady, so we expect monetary policy to help support this segment until the economy fully recovers. In an L-shaped recovery, we expect them to relax property policies to boost the sector. Alternatively, in a V-shaped recovery, consumers will have more purchasing power and we do not think that policymakers will start tightening policy prematurely, even if the market quickly reverts to a more normalized level. Q: What is our outlook for Asia fixed income markets in the cyclical six- to 12-month horizon? A: We expect central banks in Asia to maintain an easy monetary policy stance and enact a range of measures from rate reductions, reserve requirement cuts, quantitative easing and other liquidity tools to foster a conducive environment for growth and recovery. However, performance in Asian fixed income is likely to be uneven, with credit differentiation becoming increasingly large as fundamentals diverge. Overall, sectors that rely on domestic consumption are more likely to outperform in most economic recovery scenarios. In our view, it is important to be an active investor in this environment and to be selective and judicial in deploying capital, while maintaining flexibility since markets are likely to remain volatile for a while ahead.
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Q3 2020 Update from the Asia Trade Floor
Portfolio Manager, Stephen Chang discusses PIMCO’s current views on Asian credit and some investment opportunities we see.
Faster Covid-19 Recovery Cements the Case for Asian Bonds
Asia’s China-led recovery has highlighted the strength and value of Asian bonds over its global peers, with plenty of opportunities at various points of the yield curve. Strong credit fundamentals and favorable technicals built over recent years have helped Asian fixed income mitigate the sudden shock from the Covid-19 pandemic in the first quarter. Asian US dollar bonds have not only withstood the worst of the Covid-19 volatility but have come out as attractive as ever— offering investors opportunities to pick value at various points of the yield curve. As Asia, led by China, gradually stabilized in the second quarter, the J.P. Morgan Asia Credit Index (JACI) posted positive returns by early June, reversing from -3.6% in the first quarter. “As the largest economy and issuer in Asia, China anchors the risk sentiment for the region in general, and for the asset class in particular,” says Arthur Lau, head of Asia ex Japan fixed income at PineBridge Investments. “After emerging from the Covid-19 lockdown faster than other major economies, China’s recovery has injected a dose of optimism into the market.”
by PineBridge Investments
Three, technicals remain supportive — demand is largely stable, anchored by a growing Asian institutional investor base and supported by liquidity from global and regional monetary easing, which has led to a recent uptick in foreign investor inflows Supply remains healthy — new issuances have picked up since April after a brief pause in March with over half of total supply coming from China. PineBridge expects gross supply to be flat compared to last year. Four, while the default rate is expected to edge up as more vulnerable sectors face credit downgrade pressures, the market’s forecast default rate for Asian high yield remains well below that of US, European, and global high yield. To its advantage, the Asian bond market has a strong core in the more financially stable investment grade bonds, which make up approximately 80% of the market.
Meanwhile, Lau notes that the Asian “fallen angel” risk remains benign at 4%, with the risk more pronounced among Indian and Macau issuers. Macau’s gaming companies, the largest issuers in the territory, are weighed down by the collapse in tourism, while Moody’s recently downgraded India’s sovereign rating. No shortcuts to opportunities Asia’s recovery is likely to be uneven across sectors and markets, and some headwinds linger — for instance, a few Asian countries are still racing to contain the virus amid warnings of a second wave and US-China tensions continue to simmer in the run up to the US presidential election in November. To Lau, an active investor, this makes for an environment with highly dispersed returns. Asian sub-investment grade bonds, for instance, have been excessively discounted due to unjustified default fears and should now offer a rich hunting ground for value opportunities for active credit selectors, he says. He adds that both investment grade and high yield spreads have room to compress further, with high yield potentially offering higher upside. “We believe that investors can access differentiated returns by looking deeper into sectors and markets, including those beyond traditional benchmark allocations,” says Lau, who leads a team that manages and subadvises over US$15 billion in Asia ex Japan fixed income strategies with a zero-default track record. The PineBridge team prefers issuers that have robust cash flows, low refinancing needs in the short term, and strong ties to sovereigns. As of July 2020, the team had an overweight position on Chinese property companies and central government state-owned enterprises, but underweight on local government financing vehicles. This allocation reflects the nuances of the risk profiles of central and local government entities and their implications on sovereign guarantees. Among Chinese property issuers, which made up more than half of new Asian high yield supply in 2019 , established players with stronger balance sheets are preferred. The team is also sanguine on Indonesian quasi-sovereign issuers, Asian Tier 2 (T2) bank capital securities, and companies in India’s renewable sector, which is expected to see continued public and private sector investments. Meanwhile, the team sees continued weakness in the Indian financial sector, which has struggled with bad loans even before the pandemic. It is also avoiding commodities producers with weaker credit profiles due to the global demand slump. In times of volatility and low earnings visibility, Lau emphasizes that there is no substitute to intensive bottom-up and top-down research as well as environmental, social and governance (ESG) analysis in uncovering long-term value. “There is no shortcut to investing in Asian fixed income,” says Lau. “Thorough issuer by issuer research is key, and that cannot be accomplished without local presence and the cumulative experience of investing through numerous economic cycles.”
1. Source: J.P. Morgan, as of 8 June 2020.
2. Source: Bloomberg, PineBridge Investments, as of 29 June 2020.
3. Source: BAML, PineBridge, as of 31 December 2019.
4. Source: J.P. Morgan, as of 8 June 2020.
5. Source: J.P. Morgan, as of 31 March 2020.
6. Zero-default track record refers to the underlying securities of the portfolios managed by PineBridge Investments Asia Limited Fixed Income Team, as of June 2020.
7. J.P. Morgan, as of 31 December 2019.
Disclaimer All investments involve risk, including the loss of principal amount invested. Past performance is not indicative of future results. Any views express represent the opinion of the manager and are subject to change. We are not soliciting or recommending any action based on this material. In Hong Kong, this document is issued by PineBridge Investments Asia Limited. This document has not been reviewed by the Securities and Futures Commission (SFC). Investors should note that the website www.pinebridge.com and any other website referred to in this documents have not been reviewed by the SFC and may contain information of funds not authorized by the SFC. In Singapore, this document is issued by PineBridge Investments Singapore Limited (Company Reg. No. 199602054E), licensed and regulated by the Monetary Authority of Singapore (MAS). This advertisement or publication has not been reviewed by the MAS. Investors should note that the website www.pinebridge.com and any other website (including any contents therein) referred to in this document have not been reviewed or endorsed by the MAS.
arthur lau
Asian Bonds Offer Better Yield, Lower Duration
Asia Credit Metrics Remain Steady
Fears of a sharp increase in corporate defaults have eased as production and business activities returned to normal following the shutdowns in January and February. Despite a GDP contraction in the first quarter, China is forecast to post growth in 2020. The speed and size of fiscal and monetary easing across the region and the decisiveness of governments, particularly in North Asia, in containing the virus also played an important role in reining in a deeper crisis. Still, some Asian governments have room to exercise additional fiscal (rather than monetary) supportive measures should the outlook deteriorate in the short term, says Lau. “The Covid-19 crisis has shown yet again the resiliency of Asian bonds in the face of severe market stress,” says Lau, who has over 30 years of investing experience in Asia’s fixed income markets. The performance of Asian bonds during this period, he says, supports the case of a stand-alone allocation to the asset class as an effective diversifier in global portfolios. Four factors supporting Asian bonds Four key factors underpin the performance of Asian bonds: One, whether investment grade or high yield, Asian bonds offer better yields than their US and global bonds of the same credit quality. Durations are also lower , positioning the asset class an attractive diversifier in a global portfolio. Two, credit fundamentals are stronger than other regions. Corporate financial discipline in recent years have improved net leverage (second lowest versus other regions), and interest coverage (second highest versus other regions).
Comparison of Corporate Net Leverage (x) Comparison of Interest Leverage (x)
Asia’s Corporate Default Rate Is Expected to Remain Low Trailing 12-month Asia Non-Financial Corporate High Yield Default Rate (2008–March 2020)
Source: Bloomberg, PineBridge Investments, as of 29 June 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
Source: BAML, PineBridge Investments. Data as of 31 December 2019. Any opinions, projections, forecasts, or forward-looking statements presented are valid only as of the date indicated and are subject to change. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
Source: Moody’s, PineBridge Investments, as of 31 March 2020. 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. *APAC = Asia Pacific. Past performance, or any prediction, projection or forecast, is not indicative of future performance.
