The sector’s underperformance may pique the interest of value-oriented investors

by IFAST RESEARCH TEAM / Pic by BLOOMBERG

THE Asian high yield bond segment has been one of the worst-performing bond sectors so far in 2021, with the representative iShares Barclays Capital USD Asia High Yield Bond Index ETF down — 5.4% year-to-date (in USD terms, as of Aug 5). While such poor returns may scare some investors away, the sector’s underperformance should pique the interest of value-oriented investors.

In this article, we look at three reasons why Asian high yield bonds are worth a closer look at this juncture.

1. It offers one of the highest yields anywhere in the bond market.

With interest rates still near historical lows, investors have been hard-pressed to find yield within the fixed income space.

This insatiable appetite for yield has driven yields on higher-yielding bond segments like US high yield to some of the lowest levels on record — the yield on the Barclays US Corporate High Yield Index recently fell to a new historical low of just 3.53% in early July, before rising marginally to 4.02% as of Aug 5.

In contrast, yields on the Asian high yield segment have risen precipitously since the start of the year, with the yield on the Barclays USD Asia High Yield index currently at 8.82%, up from the 6.74% at the end of 2020, making it one of the highest yielding fixed income segments anywhere in the bond market today.

2. Valuations are attractive historically, and also relative to peers.

This sharp rise in yields has made the sector much more attractive when compared against its own history, as well as on a relative basis versus other higher-yielding fixed income segments.

On an absolute yield basis, Asian high yield now offers a yield-toworst of 8.8%, a level seen only in past crises (the depths of Covid-19 pandemic in 2020 and the heightened trade war tensions between China and the US in 2018).

With lower risk-free rates today, Asian high yield looks even more attractive on a spread basis with spread levels on the sector approaching some of the wider levels seen in the depths of the Covid-19 pandemic.

Relative to US high yield, Asian high yield also offers a significant level of value, with the current spread difference (525 basis points) representing one of the widest levels on record, suggesting that Asian high yield is much cheaper relative to its US counterpart.

3. A proxy to a potential recovery in one of the hardest-hit segments.

Investors should be aware that the improved valuations (due to the sharp sell-off in Asian high yield bonds) has come on the back of a fair amount of headline risk related to China’s recent crackdown on various sectors and industries.

Within the Asian high yield universe, China is the largest component, and amongst the China issuers, the real estate segment has the largest representation.

In recent times, China has introduced measures to cool the real estate sector, including the much-debated “three red lines” to reduce leverage in the sector, which has had a direct impact on some of the more levered China real estate developers.

Recent woes surrounding China’s Evergrande Group (one of the largest issuers in most Asian high yield strategies) has also spilled over to the rest of the China real estate sector — a quick check on the year-to-date performance of Asian high yield bond components shows that the bonds from Evergrande, Fantasia Holdings Group Co Ltd, Yuzhou Group, Central China Real Estate Ltd and Aoyuan Group Ltd are some of the worst-performing, having declined between 15% and 39% so far in 2021 (as of Aug 5).

While we have little visibility on how the ongoing China real estate sector crackdown will play out, it is likely that deleveraging will hurt the near-term profitability of China real estate developers as they place a greater emphasis on liquidity.

That being said, we don’t expect crackdown measures to permanently impair the business viability of the entire sector, but rather, serve as a wake-up call to real estate companies to focus on debt reduction rather than chasing profitability.

Investors can logically expect to see a China real estate sector with a much healthier credit profile emerge post-crackdown, which would be poised for more sustainable long-term growth.

For investors who remain positive on the long-term China growth story and expect current crackdown measures to abate at some juncture, the China-heavy Asian high yield bond segment offers a proxy to the recovery of the beleaguered China real estate sector, which has been one of the key targets of government measures.

The views expressed are of the writer and do not necessarily reflect the stand of the newspaper’s owners and editorial board.