Indiscriminate selling has pushed Asian bonds’ spreads to levels wider than their fundamentals merit, according to NN Investment Partners (NN IP). The JP Morgan Asia Credit Index (JACI) offers yields exceeding 400 bps over US Treasuries – a level last seen in 2011 during the EU debt crisis. The high yield credit component has risen sharply by 500 bps to a spread of nearly 1000 bps.
NN IP believes that high yield spreads of 10 per cent are unjustified by default rate expectations. With spreads at 10 per cent, defaults will need to exceed 15 per cent for returns to be negative, yet the highest default rate seen in Asia in the last decade was 3.1 per cent in 2015. This year, NN IP expects defaults in the 3-5 per cent range.
Joep Huntjens, Head of Asian Fixed Income at NN Investment Partners, says: “The first signs of normalisation are emerging in Asian credit markets. Outflows have abated, trading liquidity of bonds has slightly improved and the return of the JACI benchmark seems to have bottomed. Our base scenario is for a sharp recovery in Asian economies in the second half of the year. The encouraging signs of increasing industrial activity in China, together with continued policy support from the Chinese government, bode well. However, the extent and pace of the Asian recovery will also depend on how quick the western economies recover.
“The current valuation of Asian credit, with once-in-a-decade spread widening, potentially offers an attractive entry point to investors who believe in Asia’s long-term growth prospects. In this asset class, we see value in the high yield space, while it will be increasingly important to avoid fallen angels.”
