fixed income
Asian credit: 3 key diversification benefits
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.
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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
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
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
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
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.
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Sources
[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
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