|While they have been attracted by the returns, investors have been alarmed by some of the credits that have attempted to access the Asian high yield market and they bemoan the lack of liquidity in the secondary market. Three leading Asian high yield investors tell EuroWeek why a rise in default rates is likely and why Chinese issuers should not be allowed into the market.
The investors are:
Brian Baker, chief executive officer, Pimco Asia, Hong Kong
Eugene Kim, chief investment officer, Tribridge Capital, Hong Kong
Joe Toh, head of structured investment, Asia, Rabobank Global Financial Markets, Singapore
How are you positioned in the Asian high yield corporate sector?
Baker, Pimco: We are focused in the double-B rated space in countries on which we have a constructive view.
Kim, Tribridge Capital: We currently have approximately $50m under management, of which half is in Asian high yield. For the most part, we are focused on the higher quality issuers that are typically rated double-B or better. We see very little value in most single-B rated names at current spread levels.
Do you have any concerns about some of the credits that investment banks are offering? If so, what are they?
Kim: Yes, we are for the most part very disappointed in the overall quality of high yield issuers which are being brought to market. Too many issuers from industries with extremely volatile cashflow characteristics are accessing the market too cheaply.
Additionally, given the lack of an established legal framework for enforcing claims in China and the lack of guarantees from operating entities in China, we do not believe Chinese issuers should be able to access the market. Also, most of the covenant packages for the transactions are below par and would normally be unacceptable to experienced high yield investors.
Baker: Some companies have tried to come to market with questionable business plans or leverage that is too high, given tightening in spreads and a more benign perception of the credit environment. Generally, the market has done a good job of not accepting the most questionable of these, but it remains important to do credit homework on any issuer.
What is your high yield investment strategy?
Toh, Rabobank: I think a focus on risk-adjusted return will be the smart approach and will free investors and asset managers to evaluate each credit on its own merit. The truth of the matter is that the big picture looks fine and macroeconomic trends remain relatively benign — or, at least, no immediate danger is looming on the horizon. Above average returns will only be available to the most efficient players who are willing to look at any credit that offers value.
Kim: We focus on larger issuers which have stable, recurring cashflows. We call these companies 'strong horses'. Even if highly levered, we are comfortable since we know the issuer's cashflows should be able to support the debt load. We try to avoid high growth, capital intensive issuers with volatile cashflows such as commodities-related or technology companies.
In which countries and sectors do you see value?
Kim: Korea and consumer non-durables.
Baker: It is really credit specific. We like some of the Chinese credits, though, for example.
Does the slim supply line put pressure on you to look at more than you would like to?
Toh: This is exactly the reason why we should remain focused on every opportunity that comes through the door.
Kim: No. Our ability to utilise leverage and derivatives allows us to generate comparable returns from investment grade credits and the credit default swaps market, which allows us to not have to buy anymore of an issue even when the new issue pipeline is thin.
Baker: We would like to see more supply. However, given our global effort and sovereign options we are not pressured to invest in companies where we do not feel the return compensates for the risk of the credit.
How far down the credit spectrum will you go if the credit story appeals to you?
Baker: We prefer to stay at high single-B or better. That said, we tend to focus less on ratings per se than on our view of the credit and the compensation relative to our assessment of risk.
Kim: We have bought non-rated and distressed credits where we were comfortable with the credit story.
With mergers and acquisitions activity expected to increase, is it inevitable that there will be more defaults in the years ahead — compared to just one in the last two years?
Baker: It is not necessarily inevitable given the growth in the region and the competitiveness of many firms, but it does increase the risk. A lot depends on the stability of the company and sector involved and how much leverage is used to accomplish the M&A. The biggest risk as it relates to defaults is probably any change in the global economic environment.
Kim: I agree that defaults should rise in the years ahead, but should just be a reversion to the norm. The surge in Asian high yield issuance has only occurred over the last 18 months. It typically takes three years from issuance for high yield issuers to start running into trouble and defaults to arise. The lack of defaults over the last two years is simply a reflection of the lack of seasoning for most Asian issues.
How important is secondary market liquidity?
Kim: Secondary market liquidity is critical. Bid-offer spreads for Asian high yield are already ridiculously wide when compared to the US high yield market. If an issuer runs into trouble and as an investor you want to sell, at least with a larger more liquid issue there will hopefully be more market makers. The last thing you want as an investor when trying to sell a small, illiquid high yield bond is to only have one market-maker since they have no incentive or need to make a reasonable market. The bond will be bid down 10 points in a minute if there is trouble since there is no competing bid in the market for illiquid issues to keep them honest.
Baker: Clearly, we prefer more liquidity to less, and larger issuers to smaller ones, so it is a factor but not the main factor. If we like the credit fundamentals, we are willing to give up a little liquidity for an appropriate amount of incremental spread.