Investors continue to demand yield, but as economic uncertainty persists around the world, and risks continue to rise, investors need to become far more selective about where yield is obtained.
Despite a recent fall in returns, the Asian high-yield bond market remains attractive for investors, with low levels of new issuances and strong demand. However, these positives have to be balanced by the recent deterioration in many fundamental factors:
- Absolute debt levels amongst Asian high yield-rated corporate are rising
- Credit-rating downgrades have outpaced upgrades over the past year, and there has been a rise in the number of lower-rated companies issuing new debt
- The Chinese property sector, which is a significant portion of the Asian high-yield asset class, may face tighter policy in many cities, following strong house price gains this year
- Valuations are expensive
It is important to avoid these minefields, taking a step back and viewing Asian high-yield exposure through a broader lens. We favour a tilt towards the highest quality sector (BB-rated and above) to minimise downside risk in the event of a market decline. A shorter maturity profile, especially on non-Chinese high-yield bonds, would also help reduce risk.
While both these come at the expense of slightly lower yields, we believe the opportunity cost is more than justified. This is not the time to be adding either long-maturity high yield bonds or lower-quality bonds in an effort to stretch for yield, in our view, especially in a rising yield environment.
US bonds and equity exposure
One of our broader investment themes right now is the need for a balanced investment allocation. There is a ‘tug of war’ between the continued search for yield and rising risks in asset classes like Asian high-yield bonds, which is why we favour exposure to comparable asset classes too – such as US high-yield bonds and high-yield equities.
While we are keeping a tight eye on the US business cycle, much of the stress in the US energy sector is now likely to be behind us. US high-yield bonds are also likely to benefit if the incoming Trump administration boosts reflation efforts with a significant fiscal stimulus and the easing of lending constraints on banks. US high yield is also a considerably more diversified asset class than Asian high yield.
Trump’s victory is likely to benefit the ‘cyclical’ high yield sectors
Within high-yield equities, we hold a bias towards ‘cyclical’ high-yield sectors. An intensive hunt for yield over the past few years has meant the ‘defensive’ sectors (such as telecoms or consumer staples) have become increasingly expensive. Donald Trump’s victory is likely to benefit the ‘cyclical’ high yield sectors if his proposed reflationary policies help lift growth. In a US equity market context, examples of such sector exposure would include financials, pharmaceuticals and technology.
Lastly, multi-asset macro strategies also offer some protection against the rising risk of a market decline in Asian high-yield bonds. This, we believe, remains key to navigating both the risks and opportunities in Asian bonds and comparable asset classes.