Outlook 2019 - Asian High Yield: Seeking capital appreciation and income potential

Outlook 2019 - Asian High Yield: Seeking capital appreciation and income potential

At current valuations, Asian and China High Yield could offer some potential capital appreciation opportunities. That said, volatility is expected to remain elevated, making our focus on bottom-up credit research and vigorous security selection more relevant than ever.

1. Income likely to be a contributor to total returns.
2. We believe that current valuations look attractive, compared to historical levels and relative to US and European High Yield.
3. We are seeing an improvement in supply and demand for High Yield bonds, on the back of China easing and an onshore bond market revival.

What is your investment outlook for Asian and China High Yield in 2019?

We believe that Asian and China High Yield valuations are at attractive levels, as High Yield spreads have widened significantly, compared to the tighter spreads back in 2017. Emerging market weakness, China’s slowdown and the US-China trade war have weakened market sentiment since May 2018 and we expect volatility to linger in 2019.

The fundamentals remain intact, with the China slowdown remaining a concern, although China’s GDP growth will likely remain above 6% for the next 2-3 years, with India and Indonesia possibly at above 7% and 5% respectively. Stronger economic growth in Asia, relative to other developed markets (such as Europe and the US), remains supportive for this asset class.

Credit quality within Asian High Yield and China High Yield is likely to remain healthy, where the smaller, lowly-rated credits with a near-term refinancing requirement, and limited capital market experience and funding channels, are likely to be tested during pockets of volatility.

The default rates of Asian and China High Yield are likely to remain low and should continue to be below US and European High Yield in the next 6-12 months.

High-yield spreads have widened significantly

Source: Fidelity International, ICE BofAML Bond Indices, ACH2 for B rated, ACH1 for BB rated and AC4G for BBB rated, as of October 2018.

What do you think could most surprise investors next year?

Asian High Yield USD net issuances have peaked in 2018 and the supply pipeline has been limited throughout the year. A potential surprise for investors could be the revival of the onshore bond market, where issuers are likely to move back to this market and issue RMB-denominated debt with lower funding.

This provides a cheaper alternative funding channel to companies, which could improve their overall financial profile. The revival of the onshore bond market will benefit China High Yield credit fundamentals, as well technicals, while offshore supply moves to the onshore market. China High Yield may benefit more from the above and potentially outperform Asian High Yield in the coming year.

With liquidity in Asian and China High Yield moderating throughout 2018, another potential surprise could be weaker liquidity, especially if volatility persists for an extended period.

Our Asian and China High Yield portfolios are defensively-positioned at the short end, with a higher percentage of maturity due within 1 year, which supports liquidity. As the short-dated instruments mature, this will allow us to reinvest and capture buying opportunities when they present themselves.

How do you plan to capture the best opportunities?

While current valuations present attractive total return potential, investors may need to tolerate a certain level of volatility for the next 6-12 months. To capture the best opportunities, investors may need to look beyond short-term liquidity and invest with a slightly longer horizon.

The portfolio’s core holdings are what we believe to be high-quality credits with proven access to funding, which should contribute to income; while a bias towards strong conviction, short-dated issuances should contribute to capital return.

We will continue to carefully add risk as and when attractive investment opportunities present themselves, while managing overall liquidity. Our overlay of quantitative models can also help us to capture potential additional return opportunities without additional credit beta risks.

To capture attractively-valued opportunities in a market with potential volatility, our Asia High Yield portfolio follows an issuer and sector-constrained approach, in order to manage concentration risks and offer diversification.

Our China High Yield portfolio follows a ‘high conviction, best ideas’ approach to capture higher return per unit of risk taken, given its more concentrated portfolio versus Asian High Yield.

Both Asian and China High Yield strategies are supported by our focus on idiosyncratic risks, with rigorous credit and securities selection provided by our extensive research team and fully-fledged investment team in China.

BRYAN COLLINS is a portfolio manager based in Hong Kong at Fidelity International. He joined Fidelity in 2006 as a fixed income trader and became lead portfolio manager for Asian high yield in 2009. Prior to joining Fidelity, Bryan held a variety of roles in Credit Suisse Asset Management in Sydney, starting as a client consultant responsible for fixed income in 2000, before eventually becoming senior trader for fixed income and foreign exchange.



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