Principal Asian High Yield Fund -- Fund Manager Interview
Q: How will rising inflation impact Asian currencies and bonds?
A: Rising raw materials costs and supply chain disruptions have led to a rise in inflation and likely in the coming months as it feeds into the goods sectors. For now, Asian central banks are viewing this as a supply side driven inflation and do not see it having a lasting impact on core inflation.
The key would be to look out for signs that there are spillovers of the higher goods inflation into services inflation and more broadly into core inflation as the post COVID recovery continues that would prompt the central banks to consider hiking rates. At this stage, Asian central banks are staying put in rates partly because they want to wait and see how the recovery would take shape with higher vaccinations underway and after the current wave of COVID resurgence we are seeing in many parts of Asia.
Another angle is that the Fed has made it clear that it sees current rise in US inflation as transitory and has bought time for itself in terms of market expectations of tapering or bringing forward rate hikes which in turn has helped to keep front end rates low and the USD subdued. CNY is supported by the improving current account surplus story with borders still closed while the recovery is ongoing. This lays a supportive backdrop for Asian currencies except in a few currencies where COVID risks remain high and very little risk premium priced.
For Asian HY, a large part of risks is in China HY and the stability of the CNY speaks of the improving risk sentiment towards China assets helped by the onshore bond inflows. This supportive risk backdrop is positive for China high yield names in general as the PBOC would be focused on growth and financial stability issues domestically rather than having to react to any CNY weakness by tightening monetary policy. Another part of the market where the bulk of the currency sensitive risk lies in Indonesian high yield names where the stability in IDR has helped the high yield names.
Q: What is your view towards Asian credits in the second half of 2021?
A: Returns in 2H is likely to be driven by carry gains as we do see further rise in yields (more moderate than what we saw in 1Q) and small spread widening offsetting part of the carry.
We see opportunities in China onshore credit conditions where the impact on China USD credits are increasingly priced in. We also feel that curves have steepened significantly and see selective opportunities in long end credit curves with sufficient spreads such as in energy related names in Asia and the risk to rates curve is a bear flattening move should the market price in earlier tapering moves or rate hikes.
COVID resurgence in some countries in Asia this year have not played out largely in the financial markets due to the view that the lockdowns would not be as severe or protracted as what we saw last year and also helped by the increasing vaccination rates in the region although they are still much lower than in the developed economies.
We don’t see much spread premium priced in COVID sensitive names across gaming or issuers coming from countries with sharp rises in COVID cases at this stage and prefer to stay defensive on these names given tighter spreads anyway.
Q:How would you describe the fundamentals of the China fixed income market?
A: The China fixed income market is still evolving and undergoing changes as the domestic capital markets develop and fixed income markets become an important part of the credit system.
A large part of the onshore bond markets is made up of Chinese government bonds and policy bank bonds which are accessible to foreign investors in the interbank market where most of the liquidity in the bond markets resides. This is where most foreign investors are involved in and they play a role in global portfolios due to its low correlation with global bonds, as a high-quality carry instrument on a rating basis and a way to get CNY exposure.
The onshore corporate bonds market grew significantly over the past 5 years as policymakers curbed the shadow banking system and reduced off-balance sheet risk on bank books which led to the growth of the corporate bonds market. There remains the need for increased credit differentiation in the corporate onshore market and we would remain selective in that market.
Q:Will defaults continue to surge in China?
A: With the market recognizing the government’s stance of gradually reducing support for non-strategic State Owned Enterprises (SOE) and Local Government Financing Vehicles (LGFV), we have seen a rise in onshore defaults, including in SOEs.
However, we are seeing onshore SOE and LGFV bond supply increase to meet credit needs to ease the pressure while Privately Owned Enterprises (POE) continue to fall. Large SOE banks that are responsible for a significant part of credit system are exposed to SOEs rather than the POEs.
Overall onshore default rates remain relatively low compared to the global markets and, with the market mostly held by onshore investors, the rise in defaults is unlikely to cause significant systemic risks within China or outside of China.
Q: Specifically, with tighter regulatory risks ahead, what is your outlook for the Chinese property sector?
A: We expect the Chinese property market to be relatively stable – supported by robust housing demand offset by tighter credit conditions that, in the long run, would ensure sustainability in the sector. The property measures intended to control developer debt levels, commonly known as the “three red lines,” would lead to increasing divergence among developers, depending on who would be able to access financing effectively. Active management in the form of credit selection and research would be key to avoid idiosyncratic risks and pick the winners in the property industry undergoing consolidation.
Some key themes to look out in the market includes stable revenue but lower margins due to higher land costs as well as increased caution towards high minority interest given potential actions by developers to meet three red lines on controlling debt.
Howe Chung Wan
Head of Asian Fixed Income & Portfolio Manager
Principal Global Investors