Download Asian High Yield Outlook

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August 2015
Asian High Yield Outlook
Asian High Yield has generated good returns in 2015 despite volatility induced by
idiosyncratic and macroeconomic events. Changing markets stress the importance of
being diversified but selective with high-conviction holdings. The Fund’s risk
management process and unique issuer and sector constrained framework has
demonstrated its resiliency through delivering return and minimising drawdowns in a
higher risk asset class. As investors continue to search for yield, Asian High Yield
remains an attractive opportunity with high income and lower duration than other fixed
income options.
HOW HAS ASIAN HIGH YIELD PERFORMED?
Asian High Yield has experienced multiple episodes of market volatility year-to-date with elevated concerns
over the Chinese property sector, Chinese equity movements (both up and down) and to a lesser extent,
poor risk sentiment due to renewed Greece concerns. Notwithstanding all that, the asset class has
performed well in the first half on the back of stable fundamentals and supportive technicals driven by
persistent demand for income. Lower duration has also benefitted Asian High Yield, as returns stand out
when compared with other asset classes which have been more affected by treasury movements ahead of
expected rate hikes in the United States.
Looking ahead, supportive themes remain in place for the balance of 2015. Central banks will maintain
accommodative monetary conditions, with potential for further easing in key Asian markets to shore up
growth, especially China and Indonesia. Corporate fundamentals should stay resilient, although
idiosyncratic risks are rising and weakness in certain sectors is expected. Understanding issuer and industry
dynamics in addition to security-level intricacies remain key return differentiators as the market continues to
evolve rapidly and we see further divergence amongst and within sectors. Furthermore, our disciplined
issuer and sector constrained approach and commitment to diversification has consistently proven to be
the best approach to managing risks unique to the Asian high yield market.
Bryan Collins
Based in Hong Kong, is the
portfolio manager of the FF
Asian High Yield Fund. He has
over 15 years of investment
experience, joining Fidelity
Worldwide Investment in 2006.
FF – Asian High Yield Fund
SICAV / Share Classes include:
ARE YOU CONCERNED ABOUT RISING DEFAULTS?
Accumulating: USD, EUR
Defaults have been relatively muted in Asia and globally due to low base rates, which should help levels
stay low over the rest of 2015. However, we will likely see more defaults and debt restructurings take place
in the metals & mining and energy sectors over the coming 12-18 months as commodity prices remain
weak. In China, asset quality is likely to continue to deteriorate, which may be noticed in the corporate
bond market, but will be more noticeable in bank loans. Nonetheless, the market effect should be contained
as deteriorating asset quality is well flagged and Chinese banks remain well provisioned and capitalised.
The role of the government supported Chinese Asset Management Companies (AMC) is also expanding
and these will play an increasing role in managing onshore deleveraging. As we know, defaults are a
lagging indicator of credit quality and companies involved would normally have faced challenges for
extended periods. For the more distressed credits in the offshore market, current bond prices are already
reflecting these challenges and at a fund level, this is where we have the least relative exposure.
Distributing: USD, HKD
Hedged: RMB, AUD, JPY, SGD,
EUR, SEK, KRW
HOW DO VALUATIONS AND TECHNICALS LOOK?
Global HY corporate spreads
Valuations remain reasonable as a whole and are attractive
relative to other global markets, and may become more so if
broader risk assets weaken. On the demand side, strong technicals
will persist as investors continue to crave income in what will remain
a low interest rate environment for some time, and Asian credit
spreads offer value compared to other credit markets. On the
supply front, offshore USD-denominated Asian High Yield issuance
has moderated from last year given reduced capital expenditure
demands (good for corporate credit profiles but reflect weaker
growth) and cheaper funding channels especially for Chinese
corporates with access to the onshore Chinese bond market (also
good for credit profiles). Therefore with abundant liquidity, income
demands and relatively less supply, Asian High Yield should remain
technically well-supported for the remainder of the year.
Source: Fidelity Worldwide Investment, BoA Merrill Lynch Indices, July 2015.
WHY IS ASIAN HIGH YIELD INCOME FALLING?
In short, falling income levels in high yield bonds reflect disruptive, structural changes in the market, prevalent in most other income
generating asset classes across the globe. With key economies keeping interest rates depressed over a prolonged period, borrowing costs globally
have declined meaningfully, which has also led to lower income and yield levels for our Fund and peers in the broader market. The overall decrease
in yields and income is due to a myriad of factors, including:
Falling Cost of Funding: Corporate funding costs have
declined meaningfully as the direct and intentional result of
monetary policy. Lower funding costs are supportive for
corporates, yet have lead to a reduction in bond coupons over
the years.
Company funding cost is falling, so is the HY universe average coupon
Slow Primary Market: We have seen a year-over-year
decline in offshore USD-denominated Asian High Yield market
new issuance. This is a result of companies reducing debt
funded capital expenditure as a natural response to
moderating macroeconomic growth and also due to
corporates taking advantage of cheaper alternative sources of
funding. Both developments support credit fundamentals for
prudent, good quality companies, and reinforce the
attractiveness of offshore credit within Asian High Yield.
Redemption of High Coupon Bonds: As yields have
declined, many higher coupon bonds (>10%) have matured,
Source: Fidelity Worldwide Investment, June 2015.
been called or refinanced, leading to a fall in the weighted
average yield of the market. The replacement of those bond
yields is challenging as that very high-yielding part if the market has shrunk meaningfully over the years.
Many of these factors are not unique to our Fund and are relevant to other asset classes, including equity dividends, property rental yields, and
bank deposits - ultimately meaning our Asian High Yield Fund still remains an appealing high-income proposition for investors. The current
gross yield of our Fund is around 7-7.5%, which is in-line with the sustainable income level of the universe. We are focused on generating
consistent, organically high level of income with stringent consideration of risk in a falling income environment. Higher yields may entail excessive
levels of risk, reduced liquidity or “inorganic” means of paying income, namely paying out of principal to artificially boost all of which might not be in
the best interest of all investors.
WHAT IS YOUR MACROECONOMIC OUTLOOK?
China: China’s growth trajectory continues to moderate over the medium term with softer global demand and a shift towards a consumer-driven
domestic economy. As an effort to support growth, the government has implemented a series of easing measures both on fiscal and monetary sides
with multiple rate cuts and changes in policy. Furthermore, we have seen continued efforts and commitment by Chinese authorities in the
transformation of the economy, the currency and the capital account. Key examples include:
-
One Belt, One Road initiative – potential long term structural growth driver
Deposit Insurance Scheme – promotes financial market stability
Asian Infrastructure Investment Bank (AIIB) – supporting regional growth
Local Government Debt Swap program – reduces provincial government liquidity risk
QFII quota increases as part of capital account opening – Fidelity’s QFII quota was increased to US$1.2bn earlier this year
IMF Special Drawing Rights (SDR) – long term process of internalising the Renminbi
Overall, we view government easing and reform as positive developments for the Chinese economy and in return for the Asian credit market.
The increased pace of easing and reform measures suggest some urgency; however the Chinese authorities continue to display a clear willingness
and strong ability to effect change. We expect a modest pick-up in economic activity on the back of these measures, but further easing will be
needed to stabilise growth into 2016. Although the recent stock market volatility has negatively affected market sentiment, the economic impact
should be muted and broader systemic risks are unlikely. With that said, China is still exposed to structural risks such as elevated leverage and
softer private consumption growth. Deteriorating asset quality is another aspect of concern, which ties back to higher leverage and the diminishing
margin of return for each additional unit of leverage. As with the reform efforts, these risks may create short-term volatility directly or indirectly to
the Asian credit markets however China’s overall base-case outlook of measured growth will be supportive to the asset class.
India: India has continued to exhibit positive momentum in 2015 with new leadership, better fiscal accounts, lower inflation and higher growth
targets going forward. As such, the nation looks to be on a stable path for the longer term after having improved last year. The new government has
also been successful in rolling out essential reforms and policies, recently laying out a public bank system recapitalisation plan. For investors, a
healthy Indian economy provides a good diversification opportunity to participate in a large domestic consumption-led country within Asia.
India will continue to offer attractive investment opportunities that are less correlated to a slowing China, but credit selection is critical. Despite the
fact that India is the second-biggest nation in the Asian High Yield universe, the Fund is underweight Indian credits in aggregate because of high
idiosyncratic risks or tight valuations across a number of issuers.
Indonesia: Indonesia remains an economy of high potential as the largest country by GDP and population in ASEAN with a healthy long-term
GDP growth rate. As in India, new leadership has had success in driving reforms and prioritising government expenditure towards more productive
outlets. Coupled with the above, low leverage on the sovereign level will continue to attract investments in the form of both debt and equity.
With that said, sizable commodity exposure, USD strength and a China slowdown pose headwinds for Indonesia and companies, particularly
weaker issuers. This would likely mean growth, although still healthy, will be below economic potential. The Fund has reduced exposure to
Indonesia in light of these challenges, and maintains underweight positions in some names, particularly in the resources sector.
WHAT ARE THE KEY SECTOR THEMES FOR THE REST OF 2015?
Property: The property sector continues to be the largest, deepest and most liquid within the Asian High Yield universe. While Chinese developers
continue to dominate the space, new issuers have emerged from India and Indonesia this year. As usual, Chinese property has been in high focus,
with weaker market sentiment in the first quarter due to rising corporate governance concerns. Investors have since regained confidence and
returned to the sector given supportive fundamentals and attractive valuations. Fundamentals are helped by policy stimulus and the
loosening of regulatory restrictions, which led to a meaningful rebound in national sales and lower inventories. This is further assisted by the
opening of onshore bond market access to many Chinese developers. Activity in top-tier cities has largely recovered; however, unsold stock in
lower-tier cities remains high and is likely to be gradually absorbed over the next 2-3 years. Real Estate Investment (REI) has steadily declined
and will likely continue to moderate over the medium term as the broader Chinese economy shifts away from traditional, highly capital intensive
sectors to a more consumer-driven economy.
The Fund remains structurally underweight the sector, but is overweight relative to the customised benchmark at around 25%, most of which is
from China but not all. With over 60 issuers across the region, underlying fundamentals vary greatly, and our issuer and sector constrained
approach allows us to be highly selective. Under the current backdrop, this is reflected in our bias against weaker, lower-rated names which tend to
have very attractive yields but have questionable longer term prospects and very poor secondary market liquidity. Generally, we are constructive on
long-term prospects for Southeast Asian property credits, as positive demographics – young populations, growing middle class, rising wages –
remain supportive.
Resources: Across many commodities, the global demand-supply backdrop remains challenging due to slowing Chinese demand and
structural oversupply. In the past year, we have seen issuers in this space come under pressure and thus remain highly cautious with our
positioning. In particular, we reiterate our concerns about the coal mining sector where some of the highest yielding, lowest credit quality names sit
in the universe. With limited visibility in the near-term, we are underweight most of the names within this space, with no holdings in many.
Over the next 1-2 years, we expect some companies within the sector, particularly those already in distress, to restructure their debt. Despite these
challenges at a sector level, lower energy prices are a particular strong tailwind for Asian economic growth, as the region is a net importer of
energy. This dynamic also helps reduce any global inflationary pressures in the near term, further mitigating any potential market concerns of US
interest rate normalisation.
Gaming: The gaming sector has raised investor concerns due to a sustained decline in gaming revenues, in large part due to the economic
slowdown and anti-corruption effort in China. Despite lower revenues, gaming companies the Fund selects have strong liquidity profiles and
credit metrics with relatively low and manageable leverage. These are also names which are more engaged in integrated gaming and the broader
entertainment business, catering to the mass market instead of the high-spending “VIPs”. Market positioning makes these companies more resilient
to declining revenues from high-stake players, protecting their credit profile. Over the next few months, we expect fundamentals to stabilise given
recent policy support and new resorts coming online.
Distressed or Defaulted Securities: Distressed credits exhibit elevated yields as they have the highest credit risk, relative default risk and are
typically much less liquid to trade, therefore the Fund applies a disciplined approach to managing the positioning and exposure to this segment. In
aggregate, we continue to be significantly underweight CCC and lower rated credits. This can lead to lower fund yields and periods of relative
underperformance, but the poor fundamentals and limited secondary market liquidity of distressed securities means the risk/return is often not
attractive and in most cases not possible to replicate. In cases where we do hold such credits, either due to high conviction or valuations, individual
positions should not be viewed in isolation, and our investment approach and commitment to diversification ensures these the positions will not
dominate the risk or return profile of the portfolio.
HOW DO YOU SEE THE MARKET PERFORMING FOR THE REST OF 2015?
For the remainder of 2015, we expect Asian High Yield to be supported by broadly stable fundamentals, strong technicals and sufficient
valuations. There are risks to certain issuers and sectors which might produce pockets of weakness or volatility, but the Fund is well-positioned to
take advantage of any market dislocations if we see value. As we move closer to the early stage of US policy normalisation, a highly anticipated
event, we expect rate increases to be gradual and while there is a small risk that the pace of rate hikes will be accelerated due to unexpected
inflationary pressures (potentially due to a strong rebound in oil), Asian High Yield, as a shorter duration, high income asset class, should be more
insulated versus other asset classes.
As income is the primary driver for total return in the longer term, over time we would expect the total return earned to be close to the yield level of
the fund, which is currently 7-7.5% on a gross basis. The role of income to total return also means staying invested remains key.
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