Asia Credit Market Outlook 2018
1. Global markets stayed upbeat for most of 2017. Was it a good year for the Asia credit market too?
2017 was the first time that all major economies showed signs of growth since the global financial crisis. On the back of the strong economic fundamentals, the Asia credit market recorded another year of good returns and low default rates despite a selloff in the China bond market in the fourth quarter. Triggered by the Chinese government’s renewed warnings about high leverage and corporate debt, the selloff has sent bond prices lower. We believe the consolidation of valuations has set the stage for a better performance in early 2018.
By staying agile with our fixed income investment strategy, our flagship high yield bond fund, which mainly invests in the Greater China region, once again achieved an outstanding result, gaining more than 10% in 2017. Meanwhile, our fixed income capability continues to be recognized by industry peers. In 2017 alone, we received five industry awards for the performance of our fixed income strategy. Our flagship high yield bond fund was also awarded six coveted titles.
2. What is your investment outlook for the Asian high yield bond market in 2018?
We expect the Asian high yield bond market to remain positive this year on the back of solid global fundamentals and a stable macro environment. Moreover, rising purchasing power and demand for papers from yield-seeking investors will provide further support to credits in the region. Asian economies, especially China, continue to enjoy higher growth than the rest of the world and generally ample liquidity, which supports the credit fundamentals of corporates in the region. With improving corporate fundamentals, Asian bonds’ overall corporate default rate, which has stayed below 5%1 since 2010, will likely remain in the low-single digits in 2018, while the expected yield for Asian bonds this year is estimated to be around 4% overall.
However, US politics, as well as the Fed’s plan for future rate hikes and balance sheet reduction will be key factors to watch. In terms of US rate hikes, the market anticipates that interest rates will continue to creep higher in 2018 but increments will be small. Normally, interest rates tend to rise when the global economy improves, which may benefit lower-rated credits by boosting their profits and offsetting the impact of rate hikes.
Within the expanding Asia credit market, new issuance will likely remain strong in 2018 with China, supported by intact investor demand, continuing to dominate the primary market. In November 2017, the National Development and Reform Commission (NDRC), the main regulator of Chinese offshore bonds, reopened the pipeline for Mainland issuers to sell offshore papers. We expect the NDRC to continue to allow the issuance of offshore RMB bonds this year, albeit in a “selective” fashion, hence bringing more opportunities to new issue investors this year.
Although global bonds are not considered exceptionally cheap from a valuation perspective, the current risk-adjusted return for Asian bonds looks attractive relative to developed market papers. In China, offshore RMB bonds are more expensive now compared to onshore bonds following the NDRC’s announcement of the above policy change. However, structurally, offshore credits should be trading at a discount because they are subordinated, and the price difference will encourage more onshore issuers to enter the offshore market.
3. How do you plan to capture the best opportunities in the Asia credit market?
We see opportunities in lesser-known bonds. As the global credit market becomes stretched relative to historical levels, opportunities lie in lower-rated credits and under-researched names. However, rigorous due diligence and bottom-up analysis are required for credit selection in the lower-rated universe.
4. Can you provide an example of how you discover opportunities in under-researched credits?
A good example is the Chinese banking space. Within the banking sector, small-scale Chinese banks – many of them are first-time issuers – are mostly undervalued to a rather large extent. However, there is a diverse group of issuers among small- and medium-sized Chinese banks. We are concerned about small-scale lenders located in northeastern China as the majority of these provincial banks are lending to micro-sized companies. Issues surrounding this segment include the level of non-performing loans and bad debt arising from the micro-sized corporate clients and a small quantity of banks falsifying their financial statements. This highlights the importance of in-depth research to distinguish the good from the bad.
The views expressed are the views of Value Partners Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investors should note that investment involves risk. This commentary has not been reviewed by the Securities and Futures Commission. Issuer: Value Partners Limited.