Fund Managers Chase 'Safer' High-Yield Bonds in Asia
Fund managers in Asia are increasing their exposure to Asian high-yield corporate bonds believing regional companies with strong balance sheets and high growth are a safer bet than other alternatives.
In the first quarter of 2011 dollar-denominated bond issues for Asia, ex-Japan, totaled an unprecedented $20 billion, according to Morgan Stanley research.
“We are seeing more Asian corporate issues this year and a rising demand as well,” says Kumar Palghat, Founder & Director of Kapstream, an asset management firm based in Australia.
“Credit in Asia is better, it has strong growth and the default rate is low,” says Palghat. His flagship corporate bond fund, the Absolute Return Fund, has increased allocation to Asian issues to 10 percent from nearly zero last year.
Very few Asian issues defaulted last year, according to Tim Jagger, Head of Credit Strategy Asia Pacific, from RBS. And he expects this to continue because of strong company fundamentals.
The yield-hungry U.S. retirement funds make up a big chunk of the participants in the Asian high-yield bond market. The frenzy is driven largely by lower yields in the U.S thanks to the Fed’s easy monetary policy.
Most Asian corporate bond investors buy dollar- denominated paper for better liquidity. Jagger expects returns between 5 and 10 percent this year, which easily outstrips U.S. treasury yields.
Returns Outweigh Risks
Many Asian corporate issues are semi-government backed given the ownership structure. According to Raymond Lee, portfolio manager at Kapstream, Asian issues give you better returns with less risk.
For example, the AAA-rated 2019 bond issued by Singapore’s sovereign investment company Temasek is trading at a yield of 4.11 percent, 65 basis points above the 10-year U.S. treasury. And A-rated Korea National Oil Corp’s (KNOC) 2015 bond gives a yield of 3.65 percent compared to 2.74 percent for an A-rated bond from Dell with a similar maturity.
KNOC is 100-percent owned by the South Korean government, hence there is very little risk, says Lee.
He is upbeat about Asian countries and cites their stable currencies, favorable interest rates and profitable companies. He likes China, Hong Kong, Singapore and South Korea. And, he says, investors who fear currency risks can hedge it in the forward market and pick up the interest rate differential.
This year his Absolute Return fund invested in dollar-denominated bonds of Hutchinson Whampoa, Korea National Oil Corp, Korea Electric Power Corp, Honda and Temasek. In the high-yield space, the fund has bought China Oriental Group's 2015 bond rated BB+, which yields 6.38 percent and Singapore’s STATS ChipPac's 2016 bond rated BB+ with a 5.2 percent yield, because Lee believes they are of high-quality.
Investors need to be careful of the inflation risks though. Higher consumer prices may lead to policy tightening and in turn affect bond returns in the long-run, says Kristine Li, Senior Director of Credit Strategy at RBS.
This is especially true of Chinese property companies, whose bond issues have dominated the Asian high-yield markets this year, thanks to tightened liquidity in China.
Mainland developers have issued bonds worth $12.2 billion to international investors so far this year – more than 5 times the amount over the same period in 2010, according to data provider by Dealogic, a U.S.-based financial data provider.
At the moment most of the China property issues are rated BB or BB+ and yield around 9 percent, according to Scott Bennett, Head of Asian Credit at Aberdeen Asset Management. But if China’s property market goes bust due to over-tightening, which many analysts have been warning about, those bonds could go as low as 60 cents on the dollar, says Lee.
Some analysts also warn many lower-quality Asian companies are taking advantage of this rising demand. They are seeing many first-timers in the market with almost no track record. Some of these companies could be opportunists and have poor corporate governance, says Tanuj Khosla, Research Analyst at 3 Degrees Asset Management, a Singapore-based hedge fund that invests in Asian corporate bonds.
But most investors are optimistic. “Asia remains one of the few places where there exists an alignment of a strong banking sector, high quality sovereign balance sheets and healthy corporate fundamentals, all of which create a good environment for investment activity,” says Kapstream's Lee.