Asian credits posted an impressive 20191 thanks to a favourable investment backdrop: low yields drove capital flows into the region, issuance was robust, and corporate fundamentals remained solid2. As we enter 2020, we do not expect a significant deterioration of credit profiles, but weaker privately-owned enterprises and less strategically-important state-owned companies may face increased pressure. In this outlook, Fiona Cheung, Head of Credit, Asia, outlines why investors should remain vigilant and selective in 2020.
Asian credit markets moved higher in 2019, as credit spreads narrowed on the back of numerous positive macro factors.
In 2020, we believe that economic growth in developed countries will remain subdued, but Asian economic growth should remain relatively strong with muted inflationary pressures5. We also think that despite notable monetary loosening last year, some Asian markets, such as Indonesia and India, have additional room for accommodation to boost economic growth. Regional markets may also benefit from shifting supply chains away from China towards other manufacturing bases. Overall, this growth differentiation should continue to support regional credits if Sino-US trade tensions do not materially worsen, which is our base-case scenario.
From a supply perspective, we envisage a marginal increase in issuance with modest redemptions, which will be supportive for the market6. The trend of Asia-based institutional demand for regional credit (especially in the high-yield space)7 should continue to deepen in 2020, providing a stable “home base” that is supportive of prices during cases of amplified market volatility. We forecast that the region’s default rate, as a lagging indicator of credit quality, will gradually tick upward as a delayed reflection of slowing global growth8. As a result, we believe that security selection and bottom-up research will remain vital, particularly as idiosyncratic risks increase.
Based on these factors, our view is that Asian credit markets are poised for further gains in 2020, with greater differentiation. In Indonesia, we are constructive on high-quality credits in key sectors such as property and coal mining. While in India, we see attractive yield and steady credit standings in areas such as steel and renewables.
The Chinese economy may face ongoing headwinds from trade tensions in 2020, but we still expect it to grow by 5.5%-6%. The Chinese government should continue to provide support through targeted fiscal measures and accommodative monetary policy, but we don’t expect full-fledged credit expansion similar to 2008-2009 due to ample market liquidity and building inflationary pressures. With economic challenges and capital outflow pressure, the RMB should remain weaker, above the threshold of 7 RMB to 1 US dollar in 2020.
Looking at the market’s overall fundamentals, we do not see a significant deterioration in credit, although more modest performance is likely. We prefer the credits of strategically important state-owned enterprises (SOEs) and Local Government Financing Vehicles (LGFVs), which stand to benefit from continued government support via lending and fiscal stimulus. Examples include toll-road operators, railway operators or companies involved in strategic projects at the national level.
We are also constructive on the property sector, which accounts for significant issuance in the high-yield market and a high proportion of GDP, as well as the banking sector. Reported banks’ problem loans are improving and the capital-adequacy ratio remains healthy9, we do not anticipate a substantial deterioration in bank credits. We are less positive on more economically cyclical industries, such as industrials, which have a significant amount of debt set to mature in 2020. Having said that, we are also on the lookout for potential high-quality names in this category that may have been oversold in 2019.
Finally, defaults in China’s credit markets remain a hot topic among investors. While defaults in China have largely been concentrated in the private sector, we did see a notable change in the attitude of the Chinese government towards handling financial distress of SOEs, particularly in the banking and LGFV sectors10. We believe that the Chinese government will increasingly allow systemically unimportant commercial sectors to fail as a means to increase discipline and reduce moral hazard among onshore credit investors.
Although the topic of ESG is not new one, its importance is gaining ground in Asia. Our credit team has taken numerous steps to build our ESG capabilities, having recently become a signatory to the UN Principles for Responsible Investment (PRI).
We have now formally incorporated a robust ESG perspective into our investment analysis and decision-making processes. Apart from the traditional research and financial analysis on every issuer, our credit analysts work closely with our dedicated ESG research team to review ESG factors. In addition, a dedicated ESG taskforce for our Asian Fixed Income portfolios has been established to track the progress of our ESG integration. As we have strong local footprints in Asia, with a team of over 20 credit analysts, this differentiates us from other competitors who are traditionally focused on Europe.
Finally, our unique on-the ground presence in over 10 Asian markets gives a competitive advantage in understanding the three discrete elements of ESG. Often, the true risks of ESG can only be seen through robust on-the ground research coupled with a quantifiable measurement process. This approach allows us to “notch” ratings up and down based on a long-term view of risk.
Besides our corporate framework, we are ready to launch a new structure for sovereign credits in early 2020. This should give us a superior advantage when measuring Asian corporates and sovereigns, particularly on the “Governance” issue. We expect the “G” factor to become increasingly prominent when evaluating Asia’s corporates due to concentrated ownership.
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