Capital Ideas^TM

2022 has been a challenging year for fixed income, with global investment grade bonds down 14% over the past 12 months. Investment grade corporate bonds in Asia have outpaced US and global bonds, mainly due to their shorter duration.¹ Asian high yield on the other hand, has been dragged down by the troubles in the Chinese real estate sector. Today’s higher starting yields, however, may present an attractive entry point for investors.

Investment Director David Cheng sat down with our analysts, Franz Lathuillerie and Debbie Leow, to discuss their outlooks for credit markets and how a deep focus on fundamentals can help unearth investment opportunities, even in this environment of rising inflation and interest rates.

Given the macroeconomic headwinds of a hawkish US Federal Reserve (Fed), elevated inflation and a potential global recession, what is your outlook for the corporate bond market?

It will be difficult to position portfolios over the next few months as uncertainty will likely remain high. The risk of recession is rising and credit spreads are already starting to reflect this. Central banks will likely continue prioritising the fight against inflation over a slowing economy. This level of co-ordinated tightening could put further pressure on spreads.

However, with yields higher, we think investment grade corporate bonds should be a lot more defensive and may benefit from yield/spread compression if the Fed pauses or pivots next year on its monetary policy stance. If we take a longer-term view (24 months), we start to see some valuations that are quite attractive. For an active manager, the market could present compelling opportunities to find value, though selectivity is key.

The Chinese real estate sector has been the pain point for Asian credit investors over the past year. What led to the downturn in the property market and what is your outlook on the sector?

The Chinese government has always been worried about a housing bubble. Elevated leverage among property developers and rising house prices prompted the government to take action. In August 2020, China imposed the “three red lines” policy on property developers; the policy aimed to improve the financial health of the real estate sector by reducing developers’ leverage, improving debt coverage, and increasing liquidity.

Most developers breached at least one red line and some breached all three. One by one, Chinese developers went into financial stress, from the most levered such as Evergrande to those that were previously thought of as safe credits, such as Country Garden and Longfor.

In China, many housing projects are still in the construction stage, and house prices have fallen due to defaults by developers. We remain cautious given that property sales remain weak. Repeated lockdowns also continue to weigh on the market.

For the sector to recover, the government would need to come up with a more comprehensive policy. We would need to see greater loosening of property policies, stronger support for consumption, as well as better regulatory transparency to restore market confidence. Currently, the government seems to be focussing on increasing funding for unfinished housing projects, but this alone is unlikely to help correct the underlying structural issues the sector is facing.

1. As at 31 August 2022. Indices: Bloomberg Global Corporate Bond Index Hedged in USD, JPMorgan Asia Credit Index (JACI) Investment Grade Corporate Index and Bloomberg US Corporate Bond Index, returns in USD. Sources: Bloomberg, JPMorgan

 

Risk factors you should consider before investing:

• • This material is not intended to provide investment advice or be considered a personal recommendation.
  • The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
  • Past results are not a guide to future results.
  • If the currency in which you invest strengthens against the currency in which the underlying investments of the fund are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
  • Risks may be associated with investing in fixed income, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.