Aurelia Sax: Welcome to the PineBridge Investment podcast. I’m Aurelia Sax, deputy head of client services, EMEA. Today, we’re taking a closer look at Asia high yield with Arthur Lau, Head of Asia ex Japan Fixed Income and Co-Head of Global Emerging Markets Fixed Income. Arthur has been investing in Asia credit for more than 30 years and has seen the exciting development of the region’s high yield market.

Asia high yield is a rising asset class in the emerging market universe, attracting international investors for its competitive yields and other attractive features. Compared to other high yield markets, Asia high yield is distinctive in terms of its composition and key drivers of returns.

Thank you so much for coming on this podcast, Arthur.

Arthur Lau: Thank you for having me on the podcast.

Aurelia Sax: Let’s start with the “why.” Why should investors, particularly those outside Asia, invest in Asia high yield? Some are asking if the market is too volatile.

Arthur Lau: We believe Asia high yield adds significant value to global portfolios. If you compare yields, Asia high yield offers highly competitive yields vs US high yield, with lower duration. Holding shorter duration bonds in today’s environment is important as we believe it helps mitigate interest rate risk, particularly as the Fed has signaled a winding down of bond buying activities amid rising inflation. With careful credit selection, one can find sweet spots across ratings, sectors, and markets. As you know, Asia bonds are still underrepresented in global benchmarks, therefore a standalone allocation to Asia high yield is a good way to gain these diversification benefits.

We believe the Asia high yield volatility in 2021 was not seen since the global financial crisis in 2008/2009 and was due primarily to the Chinese property sector and, therefore, not expected to persist. There are signs of stabilization at the very least as policy begins to shift, albeit slowly. In addition, the current credit spread levels have assumed excessive default risk, which we do not think is justifiable based on fundamental and technical factors. That being said, we remain cautiously optimistic because we believe there are companies that could survive after this cycle which are unfairly punished by the market because of the current risk averse sentiment. With the expected default in the Chinese property sector lower in 2022, potential returns in Asia high yield are quite attractive compared to previous cycles. Elsewhere, Asia high yield is actually pretty stable. Therefore, we think investors should not ignore this asset class simply because of the situation in the property sector.

Aurelia Sax: In your recent 2022 Asia fixed income outlook, you spoke about opportunities in Chinese property bonds. I hope you don’t mind me asking, why are you positive on this segment of the Asian high yield market when recent headlines seem to tell a negative picture?

Arthur Lau: In terms of headlines, we have actually seen welcoming signs of policy fine tuning. Beijing’s rhetoric seems to have changed somewhat also, saying that the continued health of the property sector is important. While we don’t think this policy fine tuning is strong enough to revise the current weak investment sentiment in the sector, that does suggest further tightening in the sector may have relaxed. And of course, there is still no shortage of negative headlines. For instance, the physical property transactions in December continued to decline while the market still needs to work through the defaults that happened in 2021. Meanwhile, we also expect more defaults or distressed situations to come in 2022 in view of heavy debt maturing schedule in the coming few months. All these will remain an overhang at least in the first half of 2022. That being said, we do find current valuation very attractive as the market continues to assume significant default risk, which do not reflect the fundamentals based on our analysis. We do not mean we should be aggressive in adding risk in this sector as we are still cautious and defensive. However, we do see opportunities in selective property developers that do not have near term liquidity or refinancing risks. So, the key is credit selection as the market sold off names in this sector regardless of their credit fundamentals.

Aurelia Sax: So what do you think some investors are missing when they look at the Chinese high yield bond segment?

Arthur Lau: Besides thorough credit analysis, we think policy direction and focus are important considerations in investing in Chinese high yield bonds. While policy direction may drive the risk sentiment and increase volatility in near to medium term, careful credit selection should enable to pick winners and avoid losers despite the market volatility. This should actually offer decent returns to patient investors. Take the Chinese property sector as an example, we think as the market realizes the policy shift and selective developers continue to perform well fundamentally, opportunities actually begin to emerge.

Aurelia Sax: Aside from select Chinese property names, where else do you see opportunities for well-compensated risk in the Asia high yield space?

Arthur Lau: Besides Chinese property names, we continue to like selective commodities sectors for strategic holding while the renewable energy sector is a potential candidate for trading opportunities.

Aurelia Sax: Some investors may be turned off by the default risk in Asia high yield. How would you address this concern?

Arthur Lau: First of all, we don’t think the default risk in Asia high yield is about the whole asset class. The sharp increase in Asia high yield default last year was mainly due to the surge in default in Chinese property credits. With the few heavy index-weighted issuers defaulting, we think the most sizable default should have already been known and reflected. Nevertheless, we do expect more default to occur in the near term given the heavy debt maturing schedule in the sector in the coming few months. However, given a much smaller scale and index weighting [for these issuers], we except the default rate to actually decrease to mid-single digit this year. So, again, credit selection is the key to avoid those potential default. Outside Chinese property, we think Southeast Asia sovereigns may face a potential debt restructuring situation, i.e. default. So, it appears to us that thorough credit analysis could avoid most of the potential defaults.

Aurelia Sax: How will the ongoing pandemic, a potential US rate hike, inflation, China’s slowdown, and geopolitical tensions affect the outlook for Asian high yield?

Arthur Lau: Given that Asia high yield tends to have shorter duration profile and higher interest rate cushion, they should have less impact from a rising interest rate scenario. We think China’s slowdown could potentially be a bigger drag given that over 50% of Asia high yield are from China. Nevertheless, Chinese government has turned more accommodative in monetary support as suggested by the recent reserve requirement ratio cut. We think this risk in near term may be manageable. In terms of the pandemic, we continue to believe governments in the region are more prepared, so it should not derail the steady recovery or increase the economic risk. However, recovery in some sectors, such as gaming may be further delayed. I think one other risk investors may need to watch out is the policy risk in China. This is more unpredictable and could introduce significant selloff in a short period of time, as we have seen from the education, technology, and gaming sectors last year. So, I believe investors should make sure they have a more diversified portfolio this year.

Aurelia Sax: What’s your strategy in mitigating these potential risks?

Arthur Lau: Careful credit selection and thorough understanding and appreciation of policy direction would be critical in Asia high yield. In addition, we should also pay more attention to the ESG elements because these will offer important indicators how a credit or issuer could operate under changing environmental or regulatory regimes. Take Chinese issuers as an example, G or the governance factor would be an area that investors should put more emphasis on as Asia high yield consists of largely privately owned companies. As such, a strong G factor will offer less potential credit risk to investors.

Aurelia Sax: And what are your expectations for new issuances this year?

Arthur Lau: I think new issuance overall this year would be flat. But it really depends on the situation in Chinese property. I would expect it is hard for Chinese property issuers to come to market at least in the first half this year until we see more concrete evidence of improvement in both the physical property transactions and the funding situation for the sector.

Aurelia Sax: ESG is now becoming a key criterion for many institutional investors. How does ESG figure in your investment process? How are issuers in Asia responding to the growing demand for ESG and sustainability?

Arthur Lau: PineBridge is one of the asset managers that adopted and integrated the ESG process in our investment process at the very early stage. We incorporated ESG considerations as early as 2015. We have a very decent ESG track record of companies that we cover, which enable us to analyze the development and evolution of the ESG situation of companies over cycles. In addition, we also compare ESG scores among sector and region so that we would be able to understand and access whether a company’s ESG practice is above or below peers. This is important for us also to evaluate the valuation over cycles.

Overall, Asia issuers are aware of the need in this area, although some sectors or sovereigns have done a better job than others. In fact, we have seen a significant growth of green bonds in recent years and expect this trend to continue especially in view of China’s commitment to reach carbon neutrality by 2060. That said, we think some regulators have moved faster than others in terms of formulating policies, guidelines and etc. so that corporates could follow, while others are still pretty much a work in progress.

Aurelia Sax: If you look at new developments or trends in Asia high yield, what are you most excited about?

Arthur Lau: Despite the sharp market movement due to the Chinese property sector in 2021, we actually see a meaningful increase in interest in Asia high yield since late last year as valuation looks really interesting. For instance, we have received more inquires on how to invest in Asia high yield and in fact, we have received allocation from global asset allocators to invest in this space already.

Aurelia Sax: Could you tell us a little more about your team. How does the team respond to the rapid changes in the region? And also what is the key to your zero-default track record for Asia ex Japan?

Arthur Lau: There is no short cut to achieve a zero-default track record. It is done through thorough and dedicated credit analysis, plus good risk management and control. Our team members have been in this industry for many cycles, so they are experienced in weathering through ups and downs. In fact, some have covered the same sector for over 10 years. We also have regular discussion through various forums within the region and globally in order to make sure we understand the dynamics of each sector to size our risk budget and allocation. Our analysis is based on a forward-looking principle, which enables us to make proactive investment decisions.

Aurelia Sax: Thank you so much Arthur for all these insights. To wrap it up, what would be your 3 takeaways for investing in Asia high yield in 2022?

Arthur Lau: Number one, careful credit work, no short cut. Number two, be patient and manage the risk. Number three, partner with a manager that has strong on-the-ground presence.

Aurelia Sax: Thank you, Arthur. Well said.

To the audience, thank you for listening to this podcast. We hope you found it insightful and helpful. For more insights from our investment professionals around the world, please visit pinebridge.com.

ENDS