After a dismal end to 2011, fund managers are regaining their appetites for Asian credits. With benchmark rates remaining low and regional economies performing well, Asia is again drawing a large share of international investment.
Source: Reuters/Mike Blake
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Strong gains already this year in Asia’s credit markets are luring investors back to the asset class. Asia’s benchmark index has given total returns of 1.8% so far in 2012, on track to beat last year’s annual 4.1%, and the US Federal Reserve’s pledge to keep interest rates near zero until late 2014 has boosted risk appetite.
“The low risk-free rate has enhanced the appetite for risk assets, and emerging-market fixed income has benefited as a whole,” said David Lai, investment director, fixed income, at Prudential Asset Management, which handles investments of over US$80bn.
“We expect Asian credits will be more of a “carry play” this year, with interest accruals constituting most of the return. The robust credit fundamentals of the region as a whole will lend support to credit spreads, but capital gains from spread compression will, in our view, be modest overall at best, given a challenging economic backdrop.”
The Asia i-Traxx Investment Grade Index is trading at a spread of around 180bp over US Treasuries, a three-month low, as emerging markets benefited from hopes that the US Fed may lower borrowing costs further this year through “quantitative easing”. This easing entails purchasing securities on the market in order to bring down interest rates for mortgages and business loans.
Such a scenario has already given Asian central bankers room to pause because price pressures are showing signs of receding.
Indonesia, Thailand, Australia and the Philippines have all cut interest rates at least once in the past three months in an attempt to shore up economic growth, and many economists predict more easing to come this year from India and South Korea.
This is, of course, helping improve corporate balance sheets and strengthening the case for investing in the region’s credits.
“We expect spreads to continue to come down in the emerging-market bond area due to several factors. One is, fixed-income investors looking for yields will allocate more capital to this part of the global bond market as many of the issues here actually have better credit quality than their developed-market sovereign counterparts,” said David Pinkerton, chief investment officer of Falcon Private Bank.
However, what will need to be overcome first is a near-term hurdle in the form of the deadlock in talks between Greece and its private bondholders.
“The current macroeconomic uncertainty notwithstanding, Asian high-yield bonds stand to benefit from investor interest once Greece closes the deal with its bondholders and the US embarks on QE3,” said a research analyst at a Singapore-based hedge fund.
“Both these events may not take very long to happen and can potentially act as triggers to push to the market into ‘risk-on’ mode, much to the delight of hedge fund managers who have been sitting on cash for the last six months.”
Indeed, recent fund flows have been supportive for Asian credit as the piles of cash are now finding new homes after sitting on the sidelines through most of the last quarter.
Investors piled US$846m into emerging-market bond funds in the week to January 25, compared with US$109m in the week prior, according to EPFR Global. Hard currency funds showed inflows of US$472m, compared with the preceding week’s US$158m. High-yield funds added US$2.5bn on top of the previous week’s US$1.6bn, taking total high-yield inflows to US$7.26bn in the past four weeks.
However, the supply side has been equally opportunistic, with the pullout of European banks from the region also fuelling the demand for funding.
“European bank deleveraging would dry up a source of wholesale FX funding for banks and impede their ability to offer FX loans to clients. This would lead to higher corporate and financial supply, first-time issuers and a stickier new issue premium,” said Morgan Stanley in a strategy note at the end of January.
“We prefer Asia high-yield credit over Asia investment grade, since IG credit faces greater supply risk,” Morgan Stanley analysts wrote.
Still, fund managers expect credits to show better performance in 2012 than last year as flows remain strong and fears about Europe ease.
“Credits will behave much better this year versus 2011. Europe has been discounted, liquidity is flush and people will want to put their cash to work,” said a fund manager.
“High grade may underperform due to supply risks because of the slow fourth quarter, and issuers from Korea and India want to make it up.”
However, she said Indian banks should do well after the recent cuts to bank reserve requirements and the benign inflation outlook.
“ICICI’s results and the recap of SBI have also helped, but there could be more supply if the recovery sustains because onshore rates are still high.”
Some investors are considering a mix of high-yield and investment-grade credits to take advantage of the low interest-rate environment.
“People will take a barbell approach to investing – on the high-grade side, they will look for carry trades at the front end, while buying long-dated, high-yield paper,” said Eugene Kim, CIO at Tribridge Partners which oversees US$100m.
High yield issuance could return following the January rally, which has seen Double B rated credits surge as much as 10% in price alone.
Chinese corporate issues are expected to dominate the sector, but diversity may come from Indonesia, a country newly promoted to investment grade.
A number of companies are seeking fresh funding to refinance maturing debt (Bakrie Telecom, Gajah Tunggal), reduce interest costs (Bumi Resources) and finance expansion (Pertamina), according to independent research firm CreditSights.
“The recent debt restructurings of Indonesian shipping companies may alarm investors, although we view these issuers’ problems as specific to the shipping industry,” said a note from CreditSights.
