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Asian credit: Ingredients for high and steady income

08 October 2020

GAM Investments’ Amy Kam outlines five reasons why she is bullish on Asian credit and believes the asset class provides an attractive opportunity for investors to capture high and steady income.

We believe there are a number of key reasons why the Asian credit market offers a credible and comparable alternative to US and European high yield (HY) debt. The region’s bond market is increasingly deep and diversified with a committed and growing institutional investor base. Fundamentals remain resilient and liquidity profiles are strong, with default rates low and stable. Importantly, the market is increasingly turning green with an evidently increasing focus on renewable energy and green infrastructure. Crucially, we believe the Asian credit market has all the right ingredients to provide investors with high and steady income; for us there are five key reasons.

1) Low correlation with other EM and DM markets

The Asian credit market offers real diversification from other emerging market (EM) and developed market (DM) fixed income sectors. This is primarily due to China and India’s low correlation to DM core rates. Moreover, Asia is a beneficiary of falling commodity and energy prices, unlike most other EMs and the US. When examining the country and sector weightings of the JP Morgan Asia Credit Index for example, see Chart 1, it is evident that oil & gas (10%) and mining (1.5%) are small components of the overall benchmark. In addition, Asian credit is also an insulated asset class, supported by regional investors and dedicated international capital. Fund flows into hard currency assets are on the rise. 

Chart 1: Asia’s deep and increasingly diversified bond market

Source: GAM, 31 August 2020. Data represents diversification of the JP Morgan Asian Corporate Index. Totals may not sum due to rounding.

2) Fastest growth

Growth in the asset class is supported by economic growth across the region, particularly from China and India. Asia is expected to contribute 50% to global GDP growth in the next 10 years. Chart 2 illustrates the fast growth of EM corporate debt as an asset class from 2012-2019, with Asia leading the pack. During the period, Asia has grown to represent more than half of EM corporate bond hard currency assets, exceeding USD 1 trillion and quadrupling in size in seven years.

Chart 2: EM corporate bonds outstanding (USD billions)

Source: JP Morgan, 31 December 2019.

3) Resilient fundamentals and strong liquidity profiles

Credit quality has trended upwards across the region in recent years. Moreover, default rates across Asia over the past decade have been low and stable, see Chart 3. This is partly due to the low sensitivity to oil & gas prices. Unsurprisingly, Covid-19 has seen default rates trend upwards, however, EM markets still compare favourably to the US when looking at default forecasts. In the case of Asia, default forecasts continue to be revised down following the initial outbreak of the pandemic earlier in the year. Ultimately, the asset class is aided by improving long-term credit quality across Asian sovereign and corporate issuers.

Chart 3: The outlook for default rates post Covid-19

Source: JP Morgan, August 2020. Data excludes 100% quasi sovereign issuers. For illustrative purposes only.

4) A large asset class that is turning green

The asset class is large, scalable and turning green. Compared to other regions, Asia has a smaller fossil fuel legacy and is not reliant on higher oil prices. There is also strong political will to drive sustainability. In China, for example, state subsidies and tax breaks continue to be in place for electric vehicles / new energy vehicles (NEVs) with an ambition that 20-25% of all cars sold by 2025 will be NEVs. State investments continue to grow across charging infrastructure, ultra high voltage electrical grids, intercity transit systems and 5G technology. In February, we discussed the rise of green bonds and China’s role in the nascent climate-centric economy.

5) Higher yielding, lower volatility profile

The Asia credit market is well suited for high and steady income. On a rating and duration adjusted basis, Asia and China offer superior relative value across the board, see Charts 4, 5, 6 & 7. In addition, demand for yield continues to grow due to the lower for longer interest rate environment. Importantly, we are seeing large pension funds continue to search for high quality yields across Asia and EMs more broadly. Participation from sovereign wealth funds in the Middle East is also increasing due to a desire to diversify in low oil price environment. We believe Asian credit has the right ingredients to satisfy this demand for yield and diversification.

Charts 4 and 5: Yield / duration and option-adjusted spead / duration –  investment grade  

Source: Bloomberg and BAML, September 2020. EUR region is in EUR.

Charts 6 and 7: Yield / duration and option-adjusted spread / duration –  high yield 

Source: Bloomberg and BAML, September 2020. EUR region is in EUR.

Outlook

We are constructive on the hard currency Asian credit market, supported by China’s strong economic recovery, North Asia’s large share of the consumer electronics global supply chain, increasing regional economic collaboration, and Asia’s huge growth potential. We favour strong investment grade (IG) credit ahead of the US elections in November. Beyond this uncertainty, we believe HY credit offers a compelling risk / reward balance, supported by benign expected default rates. Over the medium to long term, we continue to favour infrastructure, real estate, technology and renewable energy sectors.  

Although this constructive outlook is based on the development of a vaccine, we acknowledge the path is still unclear. We also acknowledge that certain emerging economies still face strong headwinds due to fiscal constraints and difficulties in controlling the virus, and this could potentially spill over to other markets. It remains to be seen how the world will continue to recover from the economic crisis while overcoming geopolitical conflicts in the face of de-globalisation. We believe active management is best suited to this environment.  

To summarise, Asian credit presents an attractive opportunity for investors to capture high and steady income, helped by a number of key attributes, including its diversified nature, resilient fundamentals, low default rates and sustainable future.

Important legal information
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development. The companies listed were selected from the universe of companies covered by the portfolio managers to assist the reader in better understanding the themes presented. The companies included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice.