By Sheldon Chan, Portfolio Manager of Asia Credit Bond Strategy at T. Rowe Price
Asia credit suffered notably last year, prompting investors to think whether it will see the light at the end of tunnel in 2022. While volatility persists, we believe the market remains a high-quality segment of the emerging market fixed income opportunity set with its diversification benefits and attractive risk-adjusted returns potential.
Asia Credit: A USD 1.3 Trillion Asset Class that Is Still Growing
Asia credit grew at 17% CAGR (compound annual growth rate) between 2010 and June 2021. Despite recent negative headlines concerning the China property sector that cautioned some investors, Asian credit has continued to grow as a solid asset class, reaching A$1.8 trillion (US$1.3 trillion) 1. The asset class is well-supported by Asian investors who understand the region’s issuers better and tend to hold on to the Asia credits for their attractive risk-adjusted returns potential and downside mitigation, even during times of global market turbulence.
For example, Asia credit represents the higher quality segment of the emerging markets fixed income with the average rating profile being a BBB+ and more than 75% of them being rated as investment grade 2. Our research has shown that Asia investment grade bonds hold up better as compared with US investment grade bonds and European investment grade bonds during many periods of previous market selloffs between 2008 and 2020. Specifically, the performance of Asia investment grade bonds throughout the COVID-19 crisis underscores resilience of the asset class. It has also demonstrated a strong long-term risk/return profile, with the 10-year annualized return reaching over 5%, higher than most of the developed market bonds.3 For investors looking for diversification and sustainable income, Asia credit is an asset class that they could consider in their asset allocation in 2022.
Short Term Pain; Long Term Gain
China’s regulatory actions have sent shockwaves to the China high yield market last year, putting pressure on some higher quality names despite their relatively solid fundamentals. Even though investment grade and non-China high yield remained largely resilient, the speed and magnitude of the sell-off in China property was the largest since the global financial crisis.
Also read: Financial Market Volatility Is Unlikely To Abate Soon
Chinese high yield property developers will continue to experience volatility in 2022, especially in the first quarter. However, Chinese authorities have turned policy to accommodative. The People’s Bank of China has recently lowered the LPR (Loan Prime Rate) and signaled that it would use more monetary policy tools to stabilize the economy. We are also starting to see more direct easing toward the property industry such as partial loosening of restrictions on cash escrow accounts of developers by local governments. Policy loosening is supportive, but it is mainly benefitting non-distressed developers. And restructuring of the distressed developers has just started in the form of maturity extensions, with many more steps to come. In order for the sector to recover, we think that rebuilding stronger confidence through more positive developments is required, including reopening of access for developers to primary markets and more acquisitions and consolidations. We believe that good corporate governance is essential for the issuers to recover. However, they may still require extending their debt maturities.
However, in our view, this short-term pain might have paved the way for long-term gain. China has introduced “three red lines” policy as part of its deleveraging campaign. The policy restricts the amount of new borrowing property developers can raise each year by placing caps on their debt ratios. Looking back to the period between 2016 and 2018, when a tighter policy was placed, large developers gained their market share remarkably. The top 50 developers’ market share collectively grew from 36% in 2016 to 51% in 2018 and maintained their stable market position afterwards. The “three red lines” policy has been effective in curbing some of the more aggressive growth strategies among the developers. As a result, the industry has become more prudent with the pace of land acquisitions moderating; average land purchases declining to 24% of contracted sales in 1H21 from 39% in 2019 (and 34% in 2020).
The implementation of policies targeted at curbing property developers’ leverage should ultimately lead to a healthier sector backdrop and more sustainable balance sheets. Recovery will be divergent. We remain committed to Chinese capital markets and have a constructive outlook in a longer-term.
Credit Selection Is Key to Seek Higher Risk-Adjusted Returns
We will closely monitor two key macro themes and how they play out in the new year. The first will be the Fed and other developed market central bank’s policy tightening and their respective pace. The second will be China’s policy.
The direction of US/developed markets and Chinese monetary policy will continue to influence Asian credit markets in 2022. Against the backdrop of tighter policy direction from the US Federal Reserve with bond purchase tapering and rate hikes expected in the coming months, Chinese regulators have demonstrated a looser policy stance with a number of easing measures over recent weeks. We expect there to be more of the same looking ahead, as we head toward the Party Congress later in the year. The divergence in policy stance will be a supportive factor for Asian and Chinese credit, where buying opportunities may emerge in the months to come.
Despite the volatility in Chinese high yield property sector, the rest of the Asia Credit asset class has remained resilient. We believe a bottom-up, fundamental-driven approach will help to identify issuers with unique credit stories that lead growth in the regions. Integrating macro and ESG viewpoints in the investment process also help to select issuers more likely to emerge stronger from the cycle. As the higher quality segment of the emerging market fixed income universe, we continue to believe that Asia Credit will be able to deliver attractive risk-adjusted returns potential in the long run.
1 Sources: JP Morgan, Bond Radar, data analysis by T. Rowe Price. Asia Credit represented by J.P. Morgan Asia Credit Index Diversified. Numbers may not total due to rounding. As of 30 June 2021.
2 Source: JP Morgan, Bond Radar, data analysis by T. Rowe Price. Asia Credit represented by J.P. Morgan Asia Credit Index Diversified. As of 30 June 2021.
3 Source: U.S. IG Corporate: Bloomberg U.S. IG Corp. I.G. Index; Euro IG Corporate: Euro Aggregate; Euro Corp I.G. Corporates Index; Asia Credit IG: J.P. Morgan Asia Credit Index Diversified IG; It is not possible to invest in an index. Data analysis by T. Rowe Price. As of 30 June 2021.
