The sustained demand for yield will continue to support the demand for DM HY especially with Treasury yields remaining at low levels. While fundamental pressures could persist, we do not expect DM HY spreads to significantly widen in 2021. In fact, there may be a few positive catalysts on the horizon that could lead to tighter spreads. First, DM HY corporates have been increasing their cash balances relative to total debt, which better position them to weather further headwinds. Second, the resumption of access to funding for HY corporates, as evidenced by the strong bond supply, alleviates refinancing concerns amidst a stabilisation in economic growth. Lastly, while default rates remain elevated, the slowing pace of rating downgrades suggests that the worst could be behind us.
That said, we remain watchful for worse-than-expected default rates, especially with a resurgence in COVID-19 cases threatening the economic recovery. While DM HY issuers have shored up liquidity, absolute corporate leverage remains elevated. Hence, any unexpected deterioration in growth could lead to renewed concerns and wider credit spreads.
After the sizeable tightening of credit spreads in 2020, we see less scope for a repeat of strong capital gains in DM HY bonds this year, led by the U.S., the largest constituent. Still, the additional carry of 412 basis points (as of 30 November 2020) relative to U.S. Treasuries is reason enough to maintain some exposure to this segment. Hence, investors with a higher risk appetite could invest in select credits for a pick up in yield without taking on too much duration exposure.
We are overweight Chinese property developers given resilient property sales. Our preference remains with BB-rated names given macro uncertainties with a preferred tenor of 3 to 4 years for additional yield enhancement.
Although EM economies are rebounding from a steep decline, the recovery is advancing at different speeds across geographies, shaped by pandemic-related developments and other factors such as the pace of the rebound in major trading partners and the effectiveness of policy support. In Asia, for example, India has struggled to contain the outbreak whilst North Asia has recovered much faster and stronger. In Latin America, the outlook for Mexico remains bleak, while the fortunes of Brazil have improved substantially. One key determining factor seems to be the composition of economies - countries that rely more on manufacturing exports to power growth are in a relatively better position than those that rely more heavily on domestic demand or oil exports.
From a valuation perspective, EM HY credits may appear attractive as they offer 165 basis points spread pick up over DM HY which is higher than the 5-year average of 130 basis points (as of 30 November 2020), but large pockets of risk remain. Notably, EM sovereign default rates are at their highest since 2001. Some flashpoints to watch out for are rising geopolitical risks in some EMs (such as Russia and Turkey), and increasing bouts of pandemic-related social instability, especially in Latin America.
That said, EM sovereign defaults in 2020 have all occurred outside of Asia. In fact, Asia as a region continues to boast the strongest fundamentals within EM. Hence, we are more sanguine on Asia HY credits especially given the compelling valuations, with Asia HY offering 123 basis points over EM HY.
Our overweight stance on Asia HY bonds is supported by the favourable risk-reward. These bonds offer some of the highest yields in the credit universe at 7.3%. After narrowing considerably since March, Asia HY credit spreads have widened back to above 700 basis points as at end-November, which are attractive relative to the 5-year historical average of 512 basis points. Relative to other HY peers, Asia HY credits are also fundamentally more resilient, and yet are trading at wider credit spreads. We also see modest default risks partly due to the fact that China property credits account for close to 50% of the Asia HY benchmark.
As highlighted earlier, China is leading the recovery out of the COVID-19 pandemic and a majority of its economic activities have normalised. The robust macro fundamentals have led to improving property sales, which have witnessed positive growth on a year-on-year basis since 2Q20. No doubt, property sales growth could moderate in the medium-term as policymakers are actively promoting deleveraging within the sector. Nevertheless, the policy measures will help to reduce operational risks for these property developers, which in turn could improve the credit outlook and ultimately benefit bondholders. Meanwhile, the Chinese property sector remains relatively insulated from any potential escalation in U.S.-China tensions. In view of the above, we expect the performance of China HY property to remain resilient, which supports our overweight stance on Asia HY.
Global investors will continue to search for yield given the flush liquidity conditions. This will drive demand for Asian credits, including Asia HY bonds given their attractive carry. Nevertheless, we are mindful of potential competition from onshore Chinese credits which are offering higher yields at wider credit spreads. A mitigating factor is the modest Asia HY supply expectations especially as issuance ambitions of Chinese property developers are curbed by regulatory constraints. Hence, Asia HY prices should remain supported given the limited bond supply. As economies across the globe continue to reopen and recover, there is scope for Asia HY credit spreads to tighten further which suggests outperformance of the credit segment.
Source: Bloomberg I November 2020
Source: Bloomberg I November 2020
| Breakdown by Country and Sector |
Percentage by Market Capitalisation |
|---|---|
| China Real Estate | 48.9% |
| Macau Consumer | 5.9% |
| China Quasi-Sovereign | 3.6% |
| Hong Kong Financials | 3.9% |
| India Financials | 3.7% |
| Sri Lanka Quasi-Sovereign | 4.1% |
| India Utilities | 3.3% |
| India Metals & Mining | 3.1% |
| Others | 23.6% |
Source: Bloomberg I November 2020