In short supply: Five questions on Asian credit

August 13, 2024

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Mel Siew shares his thoughts on how policy rates, emerging technologies and a supply deficit are impacting Asian credit markets.

Asian hard-currency credit markets have been among the primary outperformers in the credit universe this year. While a favourable macro environment and strong corporate fundamentals have contributed to this narrative, a sizable supply deficit has been a bigger factor in driving down spreads.

So, what are the prospects of that changing in the near future, and where can investors find opportunities in a supply-starved market? We put the questions to Muzinich & Co. portfolio manager, Mel Siew.  

How would you assess the year so far for Asia credit?

It has been a positive year so far, which extends across all credit asset classes and is a continuation of what we started to see in late 2023. In the year to end-July, Asian high yield delivered a return of 12.4% and investment grade delivered 2.9%.¹ Both were outperformers when you look across the emerging-market universe.

The contribution to high-yield returns was broad-based by country, including an improvement in China, which had been a laggard last year. It was the same story in investment grade, where South Korean and Chinese credit benefited from growth in areas such as technology. India has also experienced tailwinds, including from foreign direct investment (FDI) and from global companies looking to diversify supply chains.  

The hard-currency credit market in Asia has been starved of supply. What are the prospects of that changing and the implications if they don’t?

The main reason is the rate differential between many Asian economies and the US. In Taiwan, Thailand, Malaysia, China, Singapore and South Korea, policy rates are currently between 2% and 3.5% - that compares to a US Fed Funds rate of 5.25-5.5%.² Asian corporates will tend to favour domestic markets when the differential is so wide. As for that changing, everyone is waiting for the Federal Reserve to cut, including Asian central banks. They are sensitive of moving too soon ahead of the Fed and damaging their currencies.

Past performance is not a reliable indicator of current or future results.

For now, it is difficult to see that differential changing. As to what that means for the broader market, it is likely the supply deficit – which was -US$36 billion in the year to end-July³ – will continue. That should be supportive for credit spreads.

If we were to see flows coming back into the Asian credit market from international investors, that could see a response from issuers wanting to diversify their sources of funding. That would be a healthy development. But in the event that doesn’t happen, we are likely to see a continuation of the current technical dynamic, of limited supply and local investors being the predominant buyers as they search for yield.

In equities, there has been a lot of attention on technology and artificial intelligence specifically. Asia is a big part of that story – are there ways to play this from a credit perspective?

For AI specifically, we see issuance from Asian issuers that are suppliers to the major global companies in this area, particularly in Korea and Taiwan. By extension, you can include electric-vehicle (EV) battery producers. The top 10 battery manufacturers are all based in Asia; 6 in China, 3 in South Korea and 1 in Japan.⁴

There is an interesting dynamic at play, because Europe and the US are far behind Asia in this part of the EV ecosystem but are subjecting Chinese producers to massive tariffs.⁵

If you want to diversify away from Chinese manufacturers to mitigate this risk, the main alternatives are in Korea and Japan. We have seen these companies tap the debt market because there are significant capital expenditure needs to build capacity. Typically, big capex requirements are not attractive from a credit perspective; however, these companies have contracts with the major EV players in Europe and the US.

China and India are usually at the forefront of investors’ minds when it comes to Asia. What themes should credit investors pay attention to in these markets?

India has a demographic advantage and international companies are keen to gain exposure to the growing consumer market.

One of the key metrics we look at is FDI. Over the past decade, India has seen FDI of over US$600 billion from a broad range of countries and into a broad range of sectors.⁶ There is a real emphasis by the government to promote manufacturing and exports. This plays into the ‘China Plus One’ investment theme, whereby many global companies are looking to diversify their supply chains and reduce their reliance on China.

Staying on the FDI theme, India has a clear need to upgrade its infrastructure. If you look at statistics such as cement consumption per head, in India it is between 250-270 kilogrammes; in China, it ranges from 1750-1850 kg.⁷ It’s a similar story for steel. This suggests there is a multi-year runway for Indian infrastructure to catch up with China, and we are seeing issuance from sectors that could benefit.

The story in China is different. There is a perception externally of China being unable to shake off the headwinds it has had to deal with over the past couple of years, especially coming out of the global pandemic.

As ever with China, government policy is a major driver of sentiment. Already this year, we have seen a number of interventions by state institutions to boost the economy, including shoring up the property market. I think we can expect more fine tuning of that policy toolkit in the coming months, which should be supportive for credit.

Looking at H2 and beyond, what do you see as the main opportunities and challenges ahead?

This is not exclusive to Asia, but the main topic of discussion is valuations and whether they are getting too tight. Now, I can make a strong case that current valuations are supported by the technical environment. I can also point to strong fundamentals in Asian credit, both in terms of the macroeconomic environment and healthy corporate balance sheets. We are currently monitoring whether the volatility and spread widening seen in August represents an opportunity to add back some of the risk we had been removing in recent months.

Looking ahead, the US elections could cause volatility, especially if one of the outcomes is a potential increase in tariffs on countries that have a trade surplus. Many of those countries are in Asia, so that could potentially be a headwind. But even then, it feels like Asian economies are strong enough to weather that if it should materialise.

On the opportunity side, there are still compelling stories in Asian high yield, albeit these are more limited than six months ago. Asian investment grade, which comprises 90% of the Asian credit universe⁸, is also interesting. It provides access to high-quality, regional credits and to the more rate-sensitive part of the credit universe that we believe should benefit from easing by the US Federal Reserve.

Looking over a longer time horizon, Asia offers exposure to themes that are difficult to access elsewhere in the credit markets. As well as EV battery producers, Asia offers access to pure play renewable energy companies in a way you don't see in other jurisdictions, where the renewables market tends to be dominated by traditional energy companies.

“Looking over a longer time horizon, Asia offers exposure to themes that are difficult to access elsewhere in the credit markets.”

Mel Siew

 

References

1.ICE BofA Platform, as of July 31, 2024
2.Trading Economics, as of July 31, 2024
3.JP Morgan, ‘EM Corporate Supply Technicals’, as of August 1, 2024
4.Visual Capitalist, ‘Ranked: The Top 10 EV Battery Manufacturers,’ as of April 22, 2024.
5.Bloomberg, ‘China’s Made-in-Europe EVs Pose New Threat to Region’s Carmakers,’ as of July 26, 2024
6.Statista, ‘Value of foreign direct investment inflows into India,’ as of July 31, 2024.
7.ICFAI Business School, ‘Cement Industry in India: A Snapshot’, as of August 23, 2023
8.ICE BofA Platform, as of July 31, 2024

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of August 2024 and may change without notice.

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Index descriptions:

H0A0 - The ICE BofA ML US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.

C0A0 - The ICE BofA ML US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have an investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million.

ADIG – The ICE BofA Asian Dollar Investment Grade Index tracks the performance of investment grade U.S. dollar denominated sovereign, quasi-government, corporate, securitized and collateralized debt publicly issued in the U.S. domestic and eurobond markets by Asian issuers. Qualifying securities have a country of risk classified as an Emerging Markets country that is part of the Asia/Pacific Region.

ADHY – The ICE BofA Asian Dollar High Yield Index tracks the performance of sub-investment grade U.S. dollar denominated sovereign, quasi-government, corporate, securitized and collateralized debt publicly issued in the U.S. domestic and eurobond markets by Asian issuers.

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