Insight
High-yield sector comes to the fore
LYDIA MAGUIRE, CONTRIBUTOR, THE AUSTRALIAN FINANCIAL REVIEW | APRIL 2019
As the desultory – even negative, in some cases – yields on developed-market government debt pushes investors toward more-risky assets, high-yield Asian bonds are one of the asset classes benefiting most. Asian 'junk' is in high demand.
It is a reversal of 2018, when the Asian high-yield sector hurt investors, as risky assets were dumped amid geopolitical uncertainty and concerns over China’s slowing growth, as well as the likely trajectory of future interest rate rises from the US Federal Reserve.
But with the pool of negative-yielding debt deepening past $US10 trillion, Asian high yield is back.
Facing challenges
“Bond yields have collapsed globally, investors are chasing yield again and Asia is offering up reasonable avenues to achieve this,” says Damien Wood, principal at Australian fixed-income investment firm Spectrum Asset Management.
Although Asian companies are facing challenges of slowing global growth, the US-China trade dispute and tighter credit conditions, default rates are projected to improve on 2018.
Moody's Investors Service says that the Asian high-yield non-financial corporate default rate will end 2019 at 2.5per cent, better than the 2018 default rate of 2.9 per cent.
But it is the “dynamics in China” that ultimately drive the health of the sector, says Raymond Lee, managing director and portfolio manager at Australian fixed-income investment house Kapstream Capital.
This is for the simple reason that China dominates the Asian high-yield space – and property developers dominate the Chinese high-yield contingent.
_________________________________________________________________________________________________________
“investors are chasing yield again and Asia is offering up reasonable avenues to achieve this.”
DAMIEN WOOD, PRINCIPA, SPECTRUM ASSET MANAGEMENT
_________________________________________________________________________________________________________
Main driver
The reason why Asian high-yield is dominated by Chinese property companies is that sector has been issuing the longest.
“Those names have been issuing for 20 years, so investors have some level of confidence – a lot of these names have issued bonds in that time, people have seen them and they haven’t defaulted. Other high-yield sectors, like China industrials, or Indonesia high-yield, for example, don’t have that history,” says Lee.
“It’s not wholly a Chinese story, but that is the main driver of the issuance.”
Many of the Chinese developers have found themselves unable to fund themselves domestically in the renminbi (RMB) market, because of tighter credit conditions, so they had to go to the international bond market and issue in $US to raise money.
Lee says that explains the surge in high-yield issuance toward the end of 2018 and the beginning of this year – issuance that has been snapped up by investors because of the yield premium.
“High-yield Chinese property companies have been offering anywhere from 7 per cent for a relatively blue-chip BB/Ba2-rated company to as high as 10 per cent to low teens, depending on the quality of the issuer,” he says.
“In US dollar terms, if you’re buying two-year or three-year paper, you get a 10 per cent annual return from a Chinese property company: obviously with yields where they are, it is hard to get that kind of return in other fixed-income markets around the world.”
Highly volatile
But this is very much a 'buyer-beware' asset class. “You get paid that return because Chinese property development is a highly volatile market – you’re buying paper from issuers who are rated ‘high yield.’ Some of them have actually defaulted in the past, so they certainly don’t come without risk,” says Lee.
For example, unrated property developer Kaisa Group – which was the first Chinese developer to default on offshore bonds, in 2015 – has returned to the market, raising $US400 million in two-year bonds, but needed to offer a coupon of 11.75 per cent to get them away.
“There are no lenders onshore, so a lot of companies whose debt was maturing have had to go offshore, and they’ve had to pay up for it,” says Lee. “That range of 7 per cent to low teens is a high return even in a high-yield world: but they had to pay that, because international investors only want to buy this sector if they are well-paid for it.
''It’s a highly volatile sector and recoveries are low: China doesn’t really have bankruptcy laws, and it is certainly not as transparent a legal system as Australia’s or Japan’s, for example.”
Geopolitical twinges
The natural buyers of this kind of paper are private bankers, hedge funds, wealthy individuals, and some family offices, Lee says. “What’s generally called ‘fast money’ – they tend to like high-yielding products. You might have some ‘real money’ managers, which are mutual funds, those whose mandates allow them to buy higher-yielding assets.
''But it is usually the more ‘fast money’-style investors, because it’s not a hugely liquid secondary market, at all. Most of the issuance in China property has been at the shorter end, three to four years, because investors don’t really want to hold a high-yield China property company for longer than that.”
And because the high-yield market is dominated by Chinese property businesses, it is problems in that market that investors fear the most.
“The China property market has had a big run in recent years, and a lot of money has gone into that sector, but it’s in a bit of a halt now. No one can call it a bubble, but that’s why it’s called a bubble. If we were to see a big fall in property prices, that would certainly hurt that issuance market,” says Lee.
The market is also highly sensitive to the global macro environment – and geopolitical twinges – but ultimately, it is defaults that hurt it most.
“If investors start to see a higher level of defaults than they were expecting, that would hurt the market as well,” Lee says.
This article was first published on April 5 2019 in the Australian Financial Review’s Special Report on Rise of Asian Liquidity
RELATED INSIGHTS AND RESEARCH
insight
Asian investors seek wider markets
A decade of quantitative easing has changed the way capital and investments are judged.
insight
Strong appetite for Australian debt in Asia
Asia is becoming a much more prominent source of debt funding to corporate Australia
insight
Asian debt market surging to new heights
A surging bond supply has been driven by the rise in Asian wealth, especially deep-pocketed Chinese investors.