Fixed Income

Asian credit: 3 key diversification benefits

Asian credit: 3 key diversification benefits
Asia Fixed Income team -

Asia Fixed Income team

In the second article of a five-part series about Asian credit1, we explore the diversification benefits of the asset class. The previous insight considered the structural factors driving the market’s growth. Look out for future pieces focusing on Asian credit as a source of efficiency in credit allocation.

 

Need to know:

  • What key diversification benefits does the Asian investment-grade credit market offer compared to the traditional global aggregate universe? 
  • We delve into three areas: duration, sector composition and credit fundamentals. 
  • The market’s combination of strong fundamentals, sector diversification and shorter duration provides a very attractive opportunity for global investors in higher quality credit.

 

Branching out to Asian credit

Asian investment-grade (IG) credit is the fastest growing global IG market, with Asian corporate supply making up 60-70% of total emerging market IG supply over recent years.2 When compared to the traditional global aggregate universe, what does the Asian IG credit market offer that’s different?

 

Benefit #1: The Asian IG credit market has a structurally shorter duration than other IG markets

A key advantage of the Asian IG credit universe is its structurally shorter interest-rate duration compared to other large IG markets, such as the US or Latin America (LatAm). As shown in figure 1, the average duration for Asian IG credit of 5.4 years is markedly shorter than for either LatAm IG credit (8.1 years) or US IG credit (8.8 years).

What’s more, with an average rating of A-, Asian IG credit is of higher average quality than its LatAm and US equivalents, at BBB and BBB+ respectively on an index basis. This means that credit spreads on a duration-adjusted basis tend to be significantly more attractive in Asian IG credit compared to other global IG markets. 

 

FIG. 1. Shorter average duration, higher average quality in Asian IG credit than comparable markets

Asia Credit #2 - FIG 1 - Avg duration-01.svg
Source: Bloomberg indices, JP Morgan indices, Lombard Odier. As at April 2022. 

 

Benefit #2: Asian IG credit offers sector diversification versus global IG credit

The universe of Asian IG credit issuers today provides access to a wide range of regions and sectors. As such, its unique sector composition can make an excellent complement to core credit allocations such as US, European or global aggregate strategies.

The sectoral benefits can be broken down as follows:

  • Greater diversification across sectors: The global aggregate universe is dominated by low-yielding government/treasury bonds, whereas Asian IG credit includes corporate and sovereign credit.
  • Access to quasi-sovereigns: Quasi-sovereigns typically account for a significant part of the Asian credit universe; they can offer valuation advantages compared to the outright sovereign bond.
  • Inclusion of large-cap, high-quality financials: Asian IG credit issuers include high-grade quasi-government-backed banks, developmental banks and export-import agency banks; these include a large proportion of Chinese state-owned enterprises and large-cap private sector firms.
  • Better access to emerging sectors such as technology: Asia has accounted for 52% of global growth in tech company revenues over the last decade and currently manufactures more than 90% of the world’s smartphones. Asian IG credit therefore provides access to a high-quality universe of technology issuers with large market capitalisations across countries including Korea, Japan, Taiwan and China.
  • Inclusion of infrastructure, utilities and power generation issuers: These sectors are critical in fuelling growth and development across economies in Asia. It’s worth noting that at 45% of total capacity, Asia has by far the largest proportion of installed renewable-energy capacity globally.

 

FIG 2. Sector composition: Asian IG credit vs global aggregate universe

Asia Credit #2 - FIG 2 - Sector composition-01.svg

Source: Bloomberg indices, JP Morgan indices. As of April 2022.

 

Benefit #3: Asian credit enjoys strong fundamentals

The Asian IG credit universe has witnessed stable credit quality over the past few years. China (A1/A+/A+)5 is the anchor for overall high average quality, which is supported by high economic and fiscal strength as well as low external risks on a sovereign level. Other major country constituents including Indonesia (Baa2/BBB/BBB) and India (Baa3/BBB-/BBB-) also enjoy investment grade credit ratings on a sovereign level. These underpin the ratings of many parts of the quasi-sovereign and corporate universe.

By comparison, US credit quality has been deteriorating over the past decade at the same time as corporate debt levels have been rising, with an accompanying increase in the risk of fallen angels – IG issuers that have been downgraded to high-yield status. The proportion of BBB debt in the US IG credit market has ballooned from 40% to close to 50% in the past decade (see Figure 7 below).

 

FIG. 3 The Asian IG credit universe has seen stable or improving ratings over time, whereas US IG ratings have deteriorated, with an increasing proportion of BBB-rated companies

Asia Credit #2 - FIG 3 - Credit universe-01.svg

Source: JP Morgan. April 2022.

 

Back in 2019 we highlighted Asian corporates’ less aggressive approach to leverage and lower default rates compared to other regions, something which feels prescient given subsequent events. On a fundamental level, a focus on profitable growth over debt-funded expansion means Asian IG corporates’ net leverage on balance sheets tends to be lower than the deteriorating fundamentals in US and European credit markets.

This is partly because a large proportion of the corporate market across China, Indonesia and India comprises state-owned enterprises, which generally do not prioritise high return on equity at the expense of stretched balance sheets. What’s more, authorities in India and China only allow corporates to issue USD bonds if they meet certain criteria, which tends to reduce the reckless pursuit of debt-funded business strategies.

 

FIG. 4 Net leverage is lower in Asian IG credit than in comparable markets

Asia Credit #2 - FIG 4 - Net leverage-01.svg

Source: LOIM. Bloomberg. JP Morgan. March 2021. Based on investment grade credit markets in respective regions.

 

Overall, we believe that the Asian credit market’s combination of strong fundamentals, sector diversification and shorter duration provides a very attractive opportunity for global investors in higher quality credit.

 

To read the full report, please use the download button provided.

 

Sources

[1] This insight uses the term “Asian credit” to refer to debt issued by Asian borrowers in hard currency.

[2] Source: JP Morgan, January 2021

[3] Index used: JP Morgan JACI IG (high grade). As at April 2022.

[4] Index used: Bloomberg Barclays Global Aggregate Index. As at April 2022.

[5] Ratings convention: (Moody’s/S&P/Fitch

important information.

For professional investor use only.
This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
Lombard Odier Investment Managers (“LOIM”) is a trade name. This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
Any benchmarks/indices cited herein are provided for information purposes only. No benchmark/index is directly comparable to the investment objectives, strategy or universe of a fund. The performance of a benchmark shall not be indicative of past or future performance of any fund. It should not be assumed that the relevant fund will invest in any specific securities that comprise any index, nor should it be understood to mean that there is a correlation between such fund’s returns and any index returns.
Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term “United States Person” shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources. Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a marketing material and has been approved by Lombard Odier Asset Management (Europe) Limited which is authorized and regulated by the FCA.
©2022 Lombard Odier IM. All rights reserved.