Asian debt has emerged as a bright spot in a global fixed income market straining for positive returns and yields. Forecast to grow faster than other regions this year and into 2021, Asian economies are expected to experience a more modest recession and a more robust recovery.1
Mr Arthur Lau, head of Asia ex Japan fixed income at PineBridge Investments, says this sets the stage for a positive outlook for Asian bonds, despite the pandemic.
Asia is the fastest-growing segment of the emerging market (EM) debt universe, driven by China.2
With a recovery picking up pace, China anchors risk sentiment for the asset class. And with Asian debt becoming an anchor for EM debt, investors are discovering relatively good value given its risk and return profile.
Returns of Asian sovereign and corporate debt so far this year have been among the highest in EM, with sovereigns and high yield leading their peers (see chart below).
A strong Asian corporate comeback
Corporate earnings expectations were pessimistic in the first quarter due to Covid-related lockdowns. But by the end of the first half, the picture started to change. "With a better-than-expected credit matrix, earnings, and earnings outlook, we've become more constructive on Asian corporate credit profiles in the second half," says Mr Lau.
One exception is the banking sector, particularly Indian banks, whose first-half earnings, he says, have yet to fully reflect potential asset quality issues.
Stronger fundamentals prior to the pandemic provided a buffer from the impact of the lockdowns and the drop in demand.
"Solid diversifying characteristics, such as higher yield and shorter duration than peers, along with relatively low default risk, further strengthen the case for greater allocations to Asian debt in global portfolios," he adds.
Default rate not a cause for alarm
The Asian bond market has a strong core in high-quality investment grade bonds, which make up approximately 80 per cent of the market.3
While the overall default rate in Asia will likely be elevated compared to last year, Mr Lau doesn't expect a wave of credit downgrades in the Asian investment grade segment.
The PineBridge team estimates that corporate fallen angel risk should stay "benign" at 4 per cent this year - of this, Macau and Indian issuers have potentially higher fallen angel risk.
Mr Lau, who leads a team that manages and sub-advises over US$15 billion in Asia ex Japan fixed income strategies with a zero-default track record4, says that Asian high yield is also poised to hold up better than its peers.
As the chart below shows, Asia's high yield corporate default rate is forecast to remain among the lowest in EM high yield and only half that of US high yield for the full year.
Stable sovereigns
Government stimulus has been critical to Asia's recovery and will likely remain an important tool going forward. However, rapidly rising government debts globally have raised concerns about the potential for a financial crisis over the horizon, while premature withdrawal of support could potentially worsen the economic outlook.
The debt situation appears more acute in the US, where the Federal Reserve's balance sheet has ballooned faster and to a greater degree than during the Global Financial Crisis.5 Except for a few frontier economies that continue to rely on IMF lending programmes, the majority of Asian governments have sound and healthy financial positions.
A more restrained stimulus approach (like China's), early recovery, and a strong starting financial position have given these economies ample room to expand support, if needed.
"Our base case is that the debt-to-GDP position in Asia, on aggregate, will remain steady this year and next. And with economic growth outpacing debt growth, we think government finances will start to improve in 2022, much earlier than in developed markets," says Mr Lau.
"This backdrop again provides a solid foundation to Asia's credit market."
Active issuer selection is still key
With a more favourable outlook, the market could see a pivot towards Asian debt. Asian credit spreads remain cheap versus the long-term average, with room for compression as the recovery continues.
Asian sub-investment-grade bonds, Mr Lau says, have been excessively discounted due to unjustified default fears and should now offer a rich hunting ground for value opportunities for active credit selectors. Yet potential short-term risks could still dampen investor sentiment: A few Asian countries have yet to effectively contain the coronavirus, and US-China tensions have the potential to escalate before and after the US election in November.
Mr Lau notes that active issuer selection continues to be important in Asian fixed income, as risks and opportunities remain highly dynamic.
"This is why we focus on in-depth research to differentiate and identify high quality issuers across sovereigns, corporate, investment grade or high yield," he adds.
"We need to understand each issuer and how their operations will evolve amid a phenomenal array of changes brought on not only by the pandemic but also by highly disruptive trends. A local presence and the experience of investing through economic cycles remain critical in achieving the differentiated outcomes our clients seek."
For more on PineBridge Investments' Asian fixed income capabilities and insights, please visit www.pinebridge.com.sg.
Footnotes:
1 IMF and PineBridge Investments, as of June 30, 2020.
2 J.P. Morgan and PineBridge Investments, as of June 30, 2020.
3 J.P. Morgan, as of June 30, 2020.
4 Zero-default track record refers to the underlying securities of the portfolios managed and sub-advised by PineBridge Investments Asia Limited Fixed Income Team, as of June 30, 2020.
5 US Federal Reserve data, accessed Sept 18, 2020.
Disclaimer:
All investments involve risk, including the loss of principal amount invested. Past performance is not indicative of future results. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. Any views express represent the opinion of the manager and are subject to change. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk. We are not soliciting or recommending any action based on this material. In Singapore, this document is issued by PineBridge Investments Singapore Limited (Company Reg. No. 199602054E), licensed and regulated by the Monetary Authority of Singapore (MAS). This advertisement or publication has not been reviewed by the MAS. Investors should note that the website pinebridge.com.sg and any other website (including any contents therein) referred to in this document have not been reviewed or endorsed by the MAS.
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