fixed income
Asian credit: a growing opportunity
In this final article drawn from our latest white paper, we look at the future for Asian credit1 and offer an overview of key indices and benchmarks. Previous insights have explored the structural factors driving the asset class’s growth, the diversification benefits it offers, how it could make a core credit allocation more efficient and why emerging market (EM) investors should reposition to put Asia-Pacific at the core of EM allocations.
|
Need to know: • We expect the Asian USD-denominated credit market to grow towards USD 2 trillion in the coming five years. |
|---|
Increasing issuance from major players
In the wake of the Covid-19 pandemic, the Asian investment-grade (IG) credit market has seen noteworthy shifts in terms of bond issuance. As a result of these trends, we expect the size of the Asian USD-denominated credit market to grow towards USD 2 trillion (from USD 1.5 trn currently) in the coming five years or so.
Many large, strong companies that had relied predominantly on domestic bank and bond markets in the past are now turning to the USD bond market, both to diversify funding channels and to access additional liquidity as a long-term trend. These include debt issuers from the Philippines and quasi-sovereigns from Thailand, as well as Hong Kong conglomerates with a rich asset base and a desire to expand funding channels.
In terms of sectors, we expect increased issuance going forward from financial, industrial and technology firms. Large banks will continue to grow their balance sheets due to rising demand amid the ongoing post-Covid recovery. Meanwhile, large-cap IG firms, including technology players Xiaomi2 and internet giants Tencent and Ali Baba, have issued long-dated debt with maturities of up to 40 years in the USD market — this opens a long-term source of financing for these businesses to fund future growth.
On a sovereign level, India has retained an IG rating despite the challenges created by Covid-19. Both S&P and Moody’s have now affirmed the India sovereign rating at Baa3/BBB- with a stable outlook, which removes a key overhang for the market. This has positive implications for Indian credit overall, as financial, quasi-sovereign and corporate issuers can comfortably obtain funding in global debt markets.
Characteristics of the baseline index
One of the most widely followed benchmarks for Asian IG credit in hard currency is the JP Morgan Asia Credit IG Index (JACI IG), which is the IG sub-index of the JP Morgan JACI baseline index. Due to its traditional market-cap-weighted calculation methodology, the baseline index has several noteworthy characteristics with important implications for investors:
- Chinese credit constitutes around 50% of the index3: this creates a significant country concentration, with China by far the largest country weight in the market-cap-weighted index.
- JACI IG includes large weights in high-quality markets such as South Korea (rated AA at a sovereign level) and the Philippines (rated BBB at a sovereign level), where yields tend to be historically tight relative to other markets.
- The wider Asia Pacific USD bond market is not included in JACI and most other Asian credit indices. This includes USD-denominated IG credit in Australia, Japan, and even the Middle East, all of which offer attractive USD debt from high-quality issuers.
Key variations of the JACI baseline index
The JACI baseline index (including the IG sub-index) is the most widely followed in Asian credit. However, its country and sector allocations are not necessarily the most efficient starting point for asset allocation. As a result, several variations that aim to tackle some of the biases in the traditional market-weighted index have become popular with investors in recent years. These include the JP Morgan JACI Diversified, as well as the JACI ESG (JESG JACI) index.
The JACI Diversified index mimics the JACI baseline index in terms of universe. However, it limits the weights of large countries by capping the amount of eligible debt outstanding, thereby reducing concentration risk. Meanwhile, the 2019 launch of the JACI ESG index incorporated environmental, social and governance (ESG) score integration, as well as positive screening (e.g., for green bonds) and exclusions for controversial sectors and UN Global Compact violators.
The key characteristics and differences between JACI IG, JACI Diversified IG and JESG JACI IG are summarised in figure 1 below.
FIG. 1 Characteristics of key Asian credit indices
|
Mandate |
US-dollar denominated debt in Asia ex-Japan markets, with a focus on sovereigns, quasi-sovereigns and financials. These three sub-sectors comprise around 67% of each index |
||
|---|---|---|---|
|
Index |
JACI IG |
JACI Diversified IG |
JESG JACI IG |
|
China weight |
47.8% |
22.7% |
30.8% |
|
Sovereign weight |
15.3% |
19.5% |
16.1% |
Source: JP Morgan as at 8 April 2022.
Notable exclusions
The lower proportion of quasi-sovereigns, especially in the JESG JACI, results from index exclusion due to low ESG scores assigned by JP Morgan as the index provider. Among the excluded companies are large index constituents – primarily within the China IG state-owned enterprise (SOE) space, such as Sinopec, CNOOC Ltd and ICBC2. In the non-SOE space, it is noteworthy that several large technology issuers such as Alibaba2 (A1/A+) are also excluded. Exclusions such as this result in a lower weight to the technology, media and telecoms (TMT) sector in the JESG JACI Index.
FIG. 2 Breakdown by country and sector of the key Asian credit indices
Source: LOIM, Bloomberg, JP Morgan Indices. April 2022.
An attractive destination for global capital
As we have highlighted in this series of articles, Asian IG credit offers high-quality opportunities which make the asset class an attractive opportunity for global investors. Specifically, Asian IG credit provides the following unique advantages:
- Growing market size: Asian credit is predominantly an IG asset class and is the largest and fastest growing component of EM corporate IG credit
- Strong demand and ample liquidity: A local and global investor base, with growing local demand and increasing foreign participation
- Portfolio diversification: Asian IG credit provides diversification benefits through:
a. Shorter duration compared to developed market credit
b.Sector diversification versus global IG credit
c.Stronger credit fundamentals compared to US IG credit - Asia's structural macro superiority over the broad EM universe: Traditional EM sovereign hard-currency index strategies no longer accurately reflect the opportunity set, owing to Russia's exclusion. Investors face an increasingly bar-belled universe with structurally challenged parts of the EM market going forward.
Given these advantages, we believe the asset class constitutes an appealing complement to a wider global IG credit allocation. As such, it will continue to grow in importance as an attractive destination for core credit allocations in an increasingly challenging global fixed income environment.
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 Any reference to a specific company or fund does not constitute a recommendation to buy, sell, hold or directly invest in the company or funds. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the funds discussed in this document.
3 Source: JP Morgan. As at 13 August 2021.
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.
