investment viewpoints

    Changing supply trends in Asian credit

    Changing supply trends in Asian credity
    Dhiraj Bajaj - CIO, Asia Fixed Income and Equities

    Dhiraj Bajaj

    CIO, Asia Fixed Income and Equities

    Changing bond supply trends in Asian credit, denominated in USD, could provide opportunities for investors, we believe.

    Net new supply of Asian corporate credit is expected to decrease this year, and the large proportion of supply emanating from high yield borrowers marks a shift. We expect more diversification of supply as Asian high yield issuance increases, with strong issuance forecast from non-Chinese, high yield names.  Accommodative policy stances in both the US and China should support credit more generally, in our opinion, amid a move away from large net supply in investment grade credit over the past years.

     

    High yield in spotlight amid gross supply dip

    Gross corporate bond issuance from Asian borrowers (excluding Japan and Australia) amounted to approximately USD 109 billion from January to April 20191. This represented below-trend growth, especially because issuance tends to be strong in the early part of the year.

    For instance, full-year gross issuance in 2017 and 2018 totalled USD 228 billion, and USD 293 billion, respectively.  We expect gross issuance this year to fall substantially from 2017, which was itself a record year. Additionally, we foresee a large number of existing bonds redeeming this year, and investors having their capital re-paid. As such, we expect net new supply to drop from approximately USD 100 million annualised (over the last five years) to likely less than USD 50 million in 2019.

    Representing some 46% of year-to-date supply, a large portion of Asian credit issuance has been in high yield. We believe this reflects two trends.  Firstly, high yield supply that was unable to be issued in 2018 (due to weak global and emerging market credit markets) is instead surfacing this year.  Secondly, Asian investment grade issuance shows a low supply trend.

    We expect Asian issuance from investment grade-rated borrowers will likely remain muted, driving investment grade credit spreads tighter. Asian investment grade supply has disappointed this year, and is likely to remain soft for several reasons:

    • There is good liquidity in onshore Asian domestic markets;
    • Chinese state-owned enterprises and asset management companies have accumulated contained leverage;
    • There is less debt-funded M&A and growth plans; and
    • Issuance from Indonesian names is more co-ordinated – for instance, all state-owned enterprise issuance is now co-ordinated at the government level.

     

    Diversification of borrower mix

    At the same time, we expect more diversification of supply from Asian high yield borrowers, with strong issuance from upcoming non-China borrowers in high yield. Non-China, new high yield issuance was low in 2018, due to emerging market Asia volatility, particularly in India and Indonesia.

    Indonesian corporates are using improved market conditions to term out their maturity profiles and to refinance - this is expected to continue after April’s positive election outcome when President Joko Widodo won another five-year term.

    The Reserve Bank of India has loosened rules for Indian companies to tap the offshore USD markets earlier this year, leading to many firms coming to the market with debut offerings. A liquidity crunch last year in the onshore India shadow-banking market continues to drive various non-banking financial corporates and high yield corporates to tap the global USD markets in 2019. Some of these will be first-time issuers.

    Renewable energy is a fast-growth sector in India, supported by a strong, top-down policy framework. With policy relaxation by the Reserve Bank of India, these firms are keen to raise USD-denominated funding for the next phase of growth and capex requirements. 

    Renewable energy is a fast-growth sector in India and firms are keen to raise USD-denominated funding for the next phase of growth and capex requirements

    On the other hand, various Chinese high yield companies, namely property firms, have finally managed to print large onshore renminbi bond deals in 2019. Borrowers include China Fortune Land, and Evergrande2 (which last issued onshore in 2016). This eases Chinese high yield supply denominated in USD for 2019.

    The changing supply dynamic should be further fuelled by two, key positive factors for 2019-2020, namely: (a) The US Federal Reserve providing accommodation and (b) China monetary policy loosening. A decreased supply of higher-quality credit, coupled with more diverse deals in this positive macro environment is a significant change from the last few years. Previously, there was high net supply as the Fed reduced the size of its balance sheet, hiked interest rates nine times and emerging markets faced the need to tighten domestic monetary policy.

    Now, the market appears to be shifting away from the prior large net supply in investment grade credit over the last four- to five-years, and towards subdued investment grade net supply in 2019. Additionally, the composition of high yield borrowers is changing for the first time to accommodate more non-China issuance – again this represents a first in many years.

     

    Investment implications

    We recommend increasing exposure to higher duration-times-spread for Asian investment grade credit.  This involves going longer duration and higher spread in investment grade names – typically, lower investment grade supply in a positive macro environment leads to continued spread compression over the medium term3.  That said, we see this trend progressing more gradually from now on.

    Increasing exposure to non-China high yield credit makes sense, in our view.  India, in particular, could provide opportunities as the country has seen a dearth of good high yield issuance in recent years.

    We suggest increasing diversification to new sectors, such as renewable power and other industrials and services, while containing/reducing high yield exposure to property developers.

    We believe investors will finally be able to incorporate a good deal of diversity from maiden deal offerings, mainly from India (where more than 15 deals are expected) and South East Asia.  Such offerings could especially suit investors who are comfortable moving away from market-cap focused Asian credit indices where China represents approximately 50% of the weight.

     

    sources.

    1 Source: Bloomberg, LOIM.
    2 Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document. The case studies provided in this document are for illustrative purposes only and do not purport to be recommendation of an investment.
    3 Past performance is not a guarantee of future results.

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