2024 Investment Outlook – Asia Fixed Income: High Yield

Income remains a key attribute of the Asia high yield (HY) asset class and security selection and selector allocation are paramount for generating alpha. As of 25th October 2023, the JPMorgan Asia Credit Index (JACI) HY default rate amounted to 8.8%.1 We believe generating stable income while avoiding credit events will be the key playbook for Asia HY in 2024 once again.
As we move into the coming year, we would like to highlight the following thematic topics that will be key for investors looking at the Asia HY asset class.
1. Refinancing and supply dynamics going into 2024
2. Identifying business models that are resilient enough to operate in a higher rate environment
3. Relative value between Asia HY and Asia IG
Refinancing and supply dynamics going into 2024
Source: Bloomberg, data as of 4 November. Note: Chart shows issuers rated below investment grade with minimum amount outstanding of >$200mn that have not defaulted.
In 2023, Asia HY bond supply remained low at less than US $5 billion in issues outstanding and less than 10 primary transactions (Figure 1). Going into 2024, the value of bonds maturing is expected to increase, and we anticipate more than double the amount of issuance in Asia HY relative to 2023.
As with the traditional credit analysis approach, analyzing companies for their liquidity position and refinancing plan is very critical for the high yield asset class. While this has meant a focus on analyzing short-dated bonds on the expectation that an issuer has sufficient cash on its balance sheet and banking facilities to repay debt, we would argue that this also increases the unsustainability of the capital structure as no business can continuously pay down debt without raising new capital (equity or debt), while keeping their existing asset base.
In the coming year we expect to see HY issuers think harder about refinancing options via exchanges of short-dated maturities or opportunistically accessing the primary market or utilizing the private credit market as a source of capital to tackle upcoming maturities. The role of shareholders to preserve their existing equity value will remain key in the assessment of willingness to pay. Lastly, issuers with the ability to access local funding at a lower cost than offshore funding will be able to retire or repay early offshore debt maturities in liability management exercises.
Identifying business models that are resilient enough to operate in a higher rate environment
Return on invested capital is an important concept to bring back into credit analysis as it’s a good guide of the sustainability of the issuer’s capital structure relative to its business model. Businesses with high return on invested capital are better positioned to survive in this high interest rate environment. We believe businesses with higher return on invested capital than weighted average cost of capital will be profitable, while businesses with a lower return on invested capital than weighted average cost of capital will be loss making.
Businesses that generate free cash flow in excess of short-term debt maturities are a very unique proposition for investors, as they are less sensitive to higher levels of interest rates and have the option to deleverage their capital structure as their cost of debt becomes too high relative to the cost of equity. The continued earnings recovery of the Macau gaming sector is a good example of this, where companies have been using existing free cash flow and excess cash position to pay down maturities.
In our view, the certainty of cashflow generation will be key, and this will favor issuers with stable regulations such as Indian renewables. In contrast, we remain cautious on highly cyclical and highly leveraged businesses in this backdrop, where a reduction in operational leverage could lead to a quick deterioration in financial leverage.
Relative value between Asia HY and Asia IG
Source: JP Morgan, Aladdin, Invesco
With the change in market structure over the last two years as Chinese HY has shrunk within the investment universe, we have seen more Asian HY funds with increasingly significant investment grade allocations in 2023. In our Q4 2023 outlook, we discussed the sector mix shift within the JACI HY index as Chinese HY real estate sectors faced credit events.
When we look at relative value between Asia HY and Asia IG (ex-real estate issuers), we note that the yield pick-up in high yield has reduced significantly from 7% in mid-2022 to just around 4% today (Figure 2). Part of the lower risk premia is a function of a lack of bond supply within Asia HY and higher risk-free rates which have pushed up investment grade yield levels.
From our perspective, having the ability to have a flexible allocation between investment grade and high yield will be a key source of alpha, allowing the manager to select the best risk-adjusted ideas across all ratings categories and sectors.
Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
When investing in less developed countries, you should be prepared to accept significantly large fluctuations in value.
Investment in certain securities listed in China can involve significant regulatory constraints that may affect liquidity and/or investment performance.
Footnotes
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1
JPMorgan research