The Case for Asian Credit

Introduction

The Asian corporate credit market has grown rapidly over the last decade. From a USD141billion market cap in 2008, the Asian credit market had a market cap of USD895 billion at the end of 2018 (Figure 1).

This growth in the size and scale of issuance is an important reason why we’re bullish on Asian credit. Other reasons, all explained in more detail below, include the emergence of local investors and the correlation to US debt.

We also look at the risks of investing in Asian credit, and which areas, in particular, we are finding investment opportunities.

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Source: JPMorgan; as of end 2018.

Big Is Beautiful

The first reason we are bullish on Asian credit is the continued growth in the size and scale of issuance. As Figure 1 shows, total Asian debt stock reached USD906 billion at the end of 2018, growing at compound annual rate of 16% since 2006.

This momentum is visible in annual new issue supply data: 2017 set a high of USD294billion of total new issuance (Figure 2), before moderating slightly in 2018. As of 17 July, new issuance totalled USD188 billion, on track to surpass the 2017 issuance.

Importantly, this growth is not over-concentrated in one country, maturity or rating. Asian debt is often erroneously thought to simply be Chinese debt with a couple of other bonds thrown in. However, Chinese debt represented about 63% credit supply as of July 2019, down from 68% as of the end of 2018 (Figure 3); a trajectory that should moderate investor fears of being exposed to a Chinese debt bubble if they are invested in the asset class.

Additionally, 2019 issuance through to July 2019 has been evenly spread between maturities, with shorter-dated debt (between 0-3 years maturity) making up the biggest proportion, at 41% (Figure 4). In our view this should alleviate any concerns investors have about duration exposure in the event interest rates were to rise.

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Source: JPMorgan, Bond Radar, Bloomberg; as of end-2018.

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Source: EMDB, Bloomberg, Morgan Stanley; as of 26 July 2019.

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Source: EMDB, Bloomberg, Morgan Stanley; as of 26 July 2019.

Local Versus Foreign

Asian institutions held about 80% of the bond market as of April 2019 (Figure 5). Local investors took 74% of newly issued debt in 2018 (Figure 6); a decade previously, less than half of new issuance was held by local investors.

The increase in local participation has reduced the volatility of Asian debt compared with other emerging market regions, in our view. International investors have historically fled non-local markets during volatility periods. Local investors, because they are more familiar with their own markets, tend to sell the worst names without punishing good-quality bonds. This correlation of increasing local participation and reduced volatility is demonstrated in Figure 7. As local investors increased their share of the Asian market, it coincided with a reduction in return volatility, compared with Latin American and European emerging market debt.

The increased demand from local investors stems from high savings rates. Indeed, we believe this trend will continue as savings rates increase as a result of income and economic growth (Figure 8).

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Source: JPMorgan; as of April 2019.

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Source: JPMorgan; as of April 2019.

Fig 7. Return Volatility is Higher for EM Europe and LatAm

Source: JPMorgan; as of April 2019. Note: Return volatility based on the standard deviation of the 30-day rolling daily change.

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Source: IMF WEO, Goldman Sachs; as of February 2018.

Correlation to US Debt

Our analysis shows that the correlation between US and Asian high yield (‘HY’) indices has been 0.76 since the beginning of 2017. This correlation provides diversification opportunities in the more volatile part of the Asian credit market. For the investment grade (‘IG’) indices, the correlation is high at 0.98. The marginal spread pick-up in Asian IG over US IG means that price movements are often driven by performance of US Treasuries.

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Source: Bloomberg; as of 6 August 2019.

The Risks

As we noted above, Chinese debt as a proportion of total Asian credit has been decreasing. However, Chinese debt still accounts for about three-fifths of total Asian debt accounts. As such, any deterioration in Chinese macro conditions, such as a sharper-than-expected slowdown or tight onshore funding conditions, could weaken investor sentiment.

Secondly, geopolitical risks – specifically trade wars – are likely to remain at the forefront and are bound to generate headlines and volatility.

Third, an increase in US interest rates could see foreign capital flowing out of Asian credit. However, a loyal local investor base should help improve stability and resilience against these sort of shocks.

Current Opportunities

We are currently seeing investment opportunities in China property HY bonds. Since the Chinese property sector is still enjoying a cyclical upturn, corporate bond valuations seem fair, in our view. As such, we are focusing on a few single B names in the sector where we have high conviction on ratings upgrades.

We also like short-dated carry opportunities in Asian HY. We are particularly attracted to fundamentally strong credits offering close to 7%, with remaining maturities of less than two years. In terms of geographical focus, we are also partial to opportunities in Philippines, Indonesia, and Vietnam.

We are cautious on commodity names with a high proportion of debt in their capital structure at the current juncture of the business cycle. We believe that lower-rated bonds with high leverage are fully valued in the current yield-grab environment and could underperform materially in an economic slowdown. We also see short opportunities in financials, basic materials and government bonds.