A growing high-yield credit market set to outperform as rates rise in 2022

In the first of our interviews with John Stover, portfolio manager with Tribeca's Vanda Asian Credit fund, he explored the potential he sees right now in the Asian credit market. The rapid growth the market had seen (about 5 times in the past 10 years, with "the high yield part of that market growing by about 10 X") was, he said, set to continue in the years due to various factors among them inefficiencies - which presented opportunities in themselves - and mispricings.

You see a lot of mispricings and flow-driven moves where someone in London or New York will make a decision to allocate less capital to Asia credit.  

In this second interview, which you can watch below, John goes a little deeper on the subject of inefficiencies, touches on the state of Chinese credit given the volatility caused by defaults in the property sector - and he outlines the areas of his portfolio that are overweight and lets us in on how they performed. 

He also explained - and this was especially interesting - why high yield credit outperforms in a rising rate environment.

But what really shines through is Stover's enduring enthusiasm for the Asian markets:

I think, Asia, given the growth, and a lot of the inefficiencies you see in the market, you can find opportunities that maybe a lot of people haven't picked up on yet.

There are obviously really high growth, fast-growing companies that we're excited to be investing in.

This transcript has been edited for clarity and length 

You describe Asian credit markets as highly inefficient with a lot of opportunities. Why is that?

A lot of people on the buy-side tend to rely on a lot of the sell-side research. So research is put out by banks. But in credit in Asia, there's very little research written on any company that issues bonds.

So we are really in the trenches looking at the bottom-up fundamentals, speaking with management, doing site visits on the ground, modelling out the company's cash flows over the next several years.

And that allows us to get a leg up on the market because a lot of people aren't doing that same type of analysis on the individual company level. And that has obviously worked well for us over the past few years is I think we've been able to see changes in the business fundamentals for companies before they've actually shown up in the reported numbers.

How do you view Chinese credit given the volatility caused by defaults in their property sector?

China property was really the problem sector in the market over the past year. And we've been taking a nimble and opportunistic approach to that. We are actually a long-short fund. So we have the ability to short individual bonds. 

And we have done some of that in the China property space, particularly ones that we think the market hasn't picked up on the fact that they may come into trouble. And then certainly on the long side too, we're taking a bit of a wait and see approach. 

There's been a huge amount of regulatory tightening, not just the property sector, but also in the education space, the technology sector, gaming. 

That plus the fact that sales in the property space are falling pretty significantly. We're waiting to see visibility around an inflexion point on that before taking a more larger, long position in the space. So right now we're fairly neutral on it.

What areas of your portfolio are overweight and how have they performed?

Natural resources, we have a pretty bullish view on commodity prices. Obviously coming out of COVID, you've seen significant infrastructure stimulus in a lot of regions that's really pushing demand. 

And I think supply hasn't been able to keep up. So we think commodity prices, we have a bullish view around those and that's going to help the fundamentals of natural resources producers around the region.

You've really seen equity prices and commodity prices rise pretty substantially, but the credit markets have actually been a bit slower to pick up on that. So we're still finding really interesting opportunities and really attractive yields in that space.

In Indonesia property, it's been a bit of the opposite of what's happened in China actually. 

So if you look back two to three years ago, Indonesia property was going through a downturn and then the sales have really started to pick up over the last year. So the main position we have in this space is a company called Lippo. 
Their sales were up 90% last year. And they're much less levered than their China peers. So the balance sheet's much stronger. 

They have a recurring income with the largest hospitals, businesses and a large malls business in the country. 

So we think that's a pretty interesting opportunity given a lot of people are less focused on property, just given what's happened in China, but Indonesia's actually a completely separate market that's doing quite well over the past year.

What is a sector of interest at the moment?

Indian renewables is a space that we really like and we've seen pretty attractive yields, particularly over the last few weeks as these bonds have gotten caught off in the market sell-off, but have really strong fundamentals and a really positive long-term outlook. 

These are companies that produce solar energy, wind power, hydroelectric energy in India, where for a long time, the power generation base was fossil fuels, coal-fired, gas-fired, et cetera.

There's going to be a big shift over time that's not going to change from fossil fuel energy to renewable energy.

Renewable energy actually has a priority dispatch on the grid within India. And mostly off-takers are government agencies. So we think the credit profiles of these companies are quite strong. And they're going to continue to have opportunities to build more plants and take advantage of that shift from fossil fuel energy to renewable energy.

How does the prospect of rising rates influence high yield bonds? 

This is a really interesting topic and, I think, very topical now given the rise in yields and interest rates you've seen over the past few months. A lot of people think that credit just performs poorly in rising interest rates environments across the board. 

We've actually run the analysis, looking at the monthly returns of different yield producing asset classes over the five largest monthly moves in interest rates. And high yield credit actually performs positively in those environments, which I think surprises a lot of people. Whereas if you look at investment grade credit or sovereign bonds, they perform negatively. And there's less interest rate sensitivity for high yield credit. And also we're investing in businesses that generally tend to perform well in those environments. So we have exposure to natural resources, for instance, that can often benefit from rising yields in a rising interest rate environment.

Why does high yield credit outperform in a rising rate environment?

High yield is obviously higher yielding. And so it has lower interest rates sensitivity than other forms of credit, say investment grade or sovereign bonds. 

And part of the reason high yield can perform well in a rising rate environment is when you see rising rates, which generally is in periods when you have rising GDP growth and rising corporate profits.

That tends to compress the credit spread for high yield bonds. And so these companies are growing profits at the same time you see rising rates and rising yields. And so investors in that market tend to see the credit as less risky when you see corporate profits rising. So that compresses the credit spread. 

We actually see high yield bonds tend to perform quite well in these environments.

What drew you to work in Asian credit markets?

I came to Asia 12 years ago. When I was offered the opportunity, I jumped at it because I'd always had a fascination about the Asian region. And I saw it as a really dynamic growth story and something I wanted to be a part of. 

Fast forward 12 years, that growth is still continuing. And we see that is likely to continue in the market over the next 12 years. And comparing it to some other regions -  say the US and Europe - there's a lot of eyes on every situation. I think, Asia, given the growth, and a lot of the inefficiencies you see in the market, you can find opportunities that maybe a lot of people haven't picked up on yet. 

There are obviously really high growth, fast-growing companies that we're excited to be investing in.