With income investing back en vogue, it pays to think beyond the obvious

When it comes to investing in Asia, the narrative is familiar. Long-term growth potential, booming middle class, political and economic reform, and strong balance sheets.

These are the common talking points and whilst they make logical sense, it seems many investors remain unconvinced.

It could be because of the outsized impact of China, where underperformance and volatility in equities, coupled with an opaque operating environment, have seen many investors put the opportunity in the too hard basket.

As John Stover, portfolio manager for the Tribeca Asia Credit Strategy points out, however, Asia is much bigger than just China and there are opportunities beyond equities.

He and his team are “finding easier and more attractive opportunities in the rest of the region” and he points to countries such as India, Indonesia, Japan, Korea, and Thailand.

He also points out that: 

“Asia Pacific Bonds trade at higher yields relative to other regions for equivalent credit quality”.

So, with income investing back en vogue and many investors once again looking to add bond exposure, Stover outlines the case for thinking beyond the obvious. It's a strategy that has been paying off handsomely, with year-to-date returns for the strategy sitting at 18.05% at the end of October. 

LW: Other regions have larger credit markets, so why does Asia stand out from the rest of the world?

Stover: Asia Pacific bonds trade at higher yields relative to other regions for equivalent credit quality.

Many people are surprised to hear that default rates in Asia ex-China are lower over the past 20 years compared to the US and Europe, with recovery rates similar, and yet yields are still higher.

Our job is to find the bonds where this discrepancy is being mid-judged by the market, leading to very attractive returns.

The strategy offers Australian-based investors an AUD-hedged vehicle to access this market. We also take advantage of frequent mispricing and event-driven opportunities that come about in this fast-growing market with few active long/short competitors.

China is a dominant regional player and worth talking about independently. What is your take on the economic conditions in China and how are you viewing it as an opportunity?

There were high hopes for China’s COVID-19 reopening at the start of the year, but those hopes were quickly dashed given the lack of a sharp rebound in growth witnessed in other regions.

With property investment falling, the government has struggled to boost consumption to fill the gap and has instead relied on increased manufacturing, such as electric vehicles and renewable power components.

We must remember that Western governments actually deposited money into consumers' accounts to revive animal spirits during COVID-19. But in China, if you give a consumer a dollar, much of that is likely to be saved rather than spent, and the government has reportedly been exploring other ways to boost consumption.

We think the markets are likely overstating the weakness in the Chinese economy, and the recent lowering of geopolitical tensions with the US is likely to help. 

That said, we still have limited exposure to China, with 10% of our long book in the country and 0% exposure on a net basis. Simply put, we are finding easier and more attractive opportunities in the rest of the region.

Asian equities are a very exciting space – A lot of great companies selling products to an increasingly affluent population. Why should investors consider credit instead?

Asian markets are very exciting given the high growth in the region. Asia credit has a few main advantages over equities, namely:

1. Structural protections: A significant portion of the Asian equity market is either government-owned or majority-owned by a family, which creates misalignment with minority shareholders. Bond structures create protection from this misalignment and reduce risk.
2. Currency: Investors into Asian equities must either take local currency exposure or pay to hedge, which eats away at returns. We invest in over 90% USD-denominated bonds and the borrowers undertake the currency hedging themselves if necessary.

What is the allocation to Australia and why?

The strategy has a typical allocation to Australia of 25%. 

We have historically done very well in Australia, with annual returns ranging from 6-14% since we launched in July 2019, despite the rise in interest rates over that period. 

Tribeca’s presence in Australian equities has helped in that regard, and there are many examples where we have worked with our equity colleagues to capitalize on shifts in business fundamentals from Australian corporates. 

The new JPMorgan Asia Pacific Credit Index now includes both Australia and Japan, and we are likely to see an increased flow of funds from APAC mandates into Australian credits.

What are the other major allocations and what is the attractiveness of those regions?

The strategy currently has 25% in Southeast Asia and 15% in India. 

India is one of the fastest-growing countries in the world, with Manufacturing PMI at 55.5 and Services PMI at 58.5. Indonesia is also performing very well economically, with higher commodity export revenues and significant investment in downstream production in the electric vehicle battery value chain. 

People often think of China when they hear Asia, but there are some amazing economic stories outside of China! 

In addition, we have a significant allocation to investment-grade BBB bonds in other countries in the region, such as Japan, Korea, and Thailand.

In early 2022, the return on Asian high yield was around 12%. How has the return profile changed since then, compared with the amount of risk investors are taking?

The yield to maturity on the Asia high yield index moved from 12% to a peak of 22% in November 2022. This compares to a peak in the Global Financial Crisis of only 16%! 

Even taking out China property from the index, the yield reached 16% in November 2022. That has since fallen to 15% on the overall index and 11% excluding China property. 

The interesting thing is that the risk has not changed at all during this period, with defaults rates in Asia ex China close to zero! 

This highlights the disconnect between fundamentals and market pricing, and the opportunities available to us in this market.

Why is now an ideal time to invest in Asian credit?

Credit markets around the world have shrunk over the past year as borrowers have taken time to adjust to the sharp rise in interest rates. Meanwhile, investors have been content sitting in money-market funds and term deposits. 

Asia Pacific has had the additional headwind of defaults in the China property space, where over 80% of the private developers have already defaulted. Our strategy has always steered away from China property exposure, and default rates in APAC outside of China property remain extremely low.

This part of the cycle is typically a great time to invest in credit markets and we think the time is right to add duration. 

We’ve typically been very short duration, around three years on average to maturity until recently, but we’ve been adding in the 5–10-year bucket since mid-October as US Treasury yields approached 5%. 

As rate cuts appear on the horizon, investors will start to worry about re-investment risk and put cash to work in longer-duration bonds. The time is right to get in front of that trend.

We expect the Asia Pacific credit market to continue to grow faster than other regions in the future. The APAC government bond market is 110% the size of the US government bond market, and yet the corporate bond market is only 24% the size of the US despite GDP in the region 50% higher. The continued maturity of corporate finance in the region will create continued growth in investment opportunities for us.

What are some examples of the mispricings that exist in the Asian credit market and how do you look to take advantage of them?

Greenko: The second largest producer of renewable power in India, Greenko’s bonds traded to 12-13% yield in November 2022. Given the very strong majority shareholder (GIC, the Singapore sovereign wealth fund) and stable business profile backed by producing assets, we felt this was extremely mispriced. We added exposure and the bonds have since rallied, leading to one-year total returns of ~25% despite rising rates.

Nickel Industries (ASX: NIC): An Australian listed company with assets in Indonesia, Nickel Industries is one of the world’s largest and lowest-cost producers of nickel pig iron, a key ingredient in producing stainless steel. 

We purchased bonds in the mid-80s cents on the dollar (between 12-15% yield) on the back of some negative headlines on one of the shareholders. We felt the bonds were mispriced given the low leverage (less than 1x Net Debt / EBITDA) and strong free cash flow generation. 

The bonds were refinanced earlier this year and the company brought in Astra, one of the strongest conglomerates in Indonesia, as shareholders. This led to a one-year total return of 21%.

Beyond these, we also like 5-10 year investment-grade bonds around the region at 7-10% yield, which we think will start to gain favour as investors start to add duration.

Learn more

The Asian corporate bond market (including Australia) is one of the world’s fastest growing asset markets yet remains highly inefficient and structurally mispriced - representing a rich  source of alpha. Find out more