Demand for high yielding investment vehicles has been growing across Asia and is particularly strong in countries such as Australia, Hong Kong and Singapore. However, despite this, the issuance of high yield Asian bonds denominated in US dollars has actually declined over the past year. Total issuance of USD Asia high yield bonds in 2015 was $29.4bn, a substantial drop from the $40.6bn recorded in 2014, according to UBS Wealth Management. Nervousness about the economic backdrop appears to have allowed caution to get the better of appetite.

The accompanying Dealogic table shows that Asia Pacific (ex-Japan) high yield bond issuance was running at around $5.5bn to $6.9bn per quarter through most of 2014-2015 until the third quarter of 2015 when it fell off a cliff, at just $767m, followed by $1.5bn in Q4 and $1.2bn in the Q1 2016.

“The main reasons for the recent decline in high yield bond issuance in Asia are the loose monetary conditions in China and the yuan’s depreciation ,” says Devinda Paranathanthri, director, CIO, UBS Wealth Management. “As a result, Chinese corporates have tapped the onshore bond market instead of issuing USD bonds. We expect overall high yield bond issuance in Asia to decline further in 2016, making the technical picture more supportive.”

The backdrop is very changeable. In March, emerging market currencies looked in their strongest position for 18 years, and developing nation equity markets put in their best month since October 2011, largely prompted by Janet Yellen’s dovish statement that the Fed will act “cautiously” in raising interest rates. However, since then those EM currencies that are more sensitive to the macro backdrop such as the Mexican peso and the Malaysian ringgit have weakened while the Japanese yen has been rallying strongly and gold futures for June delivery stood at around $1,260 at the end of April.

These swings are confounding because while the dollar-yen has been moving lower, risk appetite has held up reasonably well across the broader spectrum and fears about the Chinese economy look, if anything, overdone. Capital Economics’ Roger Bootle, which has long argued that undue attention is paid to the gyrations of the Chinese equity market, says that there are signs that the fiscal and monetary stimulus has stabilised the economy and an upturn may be in sight.

Tail risks

The conundrum is that while the fundamentals of the high yield market are supported by accommodative monetary policy across the world including Europe, Asia, and the US, there are a number of potential bombshells, such as international terrorism, sharp commodity and especially oil price moves as well as uncertainty over the pace of the European economic recovery. In addition, 2016 will see a procession of critical political events such as the UK’s so-called Brexit referendum in June and German and US elections, which could all result in more market volatility.

“The first quarter was a good example of how exogenous shocks and fundamentals can affect the market,” says Fabrice Jaudi, fixed income CIO at S&P Investment Advisory Services. “Volatility was extremely high in January and February following the terrorist event in Belgium and uncertainty on monetary policy in the US.

“On the other hand, in March, amid talks from major oil producers around stabilising global oil production , and Yellen’s dovish speech, the high yield market bounced back, more than offsetting the negative performance of the two previous months. This shows how positive the high yield market could be despite existing exogenous shock threats, if more upbeat news emerges in the current context of attractive yields.”

M&A activity

The shift to risk-off in the first quarter left many potential corporate issuers waiting to assess when investors would become more confident, so when in April computer storage maker Western Digital issued a $5.6bn slice of debt to fund its acquisition of SanDisk, it was closely scrutinised. The issue was the biggest piece of junk-rated mergers and acquisitions (M&A) debt since September and was widely seen as a test of investor appetite that could pave the way for even riskier transactions. But in the event the underwriters had to scale it back to $5.225bn and switched a greater proportion of the package to investment grade.

“The Western Digital deal is corroboration of current market sentiment, which is still willing to accept increased levels of risk, but reticent to move further out the risk curve without adequate premium compensation,” says Anthony Perrotta, partner, global head of research & consulting, at TABB Group. “Overall, the sentiment for higher yielding assets across the region is still uncertain. Investors still want to pick up yield, but are reluctant to do so in the face of non-transparent financials, central bank uncertainty, and other factors that make them question the risk premiums accompanying deals.”

“Demand is multi-dimensional, as historically low nominal yields are making it very difficult to achieve return targets. As long as rates remain low and defaults do not increase, it is likely that investors will remain comfortable reaching for riskier credits.”

Nonetheless another downdraft could halt issuance, leaving underwriters with as much as $15bn of so-called hung deals, according to one anonymous banker quoted in The Financial Times, and damaging corporates that need funding. Default rates seem unlikely to shoot up, however, because since the Asian financial crisis in the late 1990s, most Asian bond issuers have become more cautious about incurring external liabilities.

Globally, M&A has picked up, particularly in pharma, healthcare and technology. However, the Asian bond market is very different from the US. “As most Asian bond issuers are owned or controlled by Asian governments or families, there are less M&A activities in Asia,” says Ken Hu, CIO, fixed income, Asia Pacific at Invesco. “This means I have not seen a similar story to Western Digital in Asia for many years.”

Asia home bias

Emerging market sovereigns and corporates have returned approximately 5.1% and 4.3%, respectively, year-to-date with most of the demand coming from local onshore investors searching for yield. It’s a market that tends to become more domestic when uncertainty rises.

“The demand for Asian high yield bonds is very home-biased nowadays – Chinese investors buying the Chinese high yield bonds, Singaporean investors buying Singaporean high yield bonds, Indian investors buying the Indian high yield bonds,” adds Mr Hu.

“High domestic saving rates in Asia support such home-biased demand. Home-biased demand usually becomes strong in light of rising global uncertainties. When the global uncertainties are not high, the Asian high yield bonds usually trade at higher yields than the US high yield bonds for similar credit ratings and maturities, or so-called Asian premiums.

The home-biased demand within Asia has been meaningfully narrowing-down the Asian premiums since last year. “As Asian countries, such as China, have been cutting interest rates to drive down the yields of their domestic corporate bonds, US dollar-denominated Asian high yield bonds have become more attractive to the local Asian investors.”

Rates & dividends

Looking ahead, high yield performs best when an economy emerges from recession and shows signs of recovery, which in terms of monetary policy equates to a low interest rate environment or the start of an interest rate-hike cycle. “This is likely where the US and European economies currently are, and where Asia is getting with interest rates half the levels they were 12 months ago,” adds Mr Jaudi.

Demand for income from local pension schemes is another significant driver, with many pension funds taking a greater activist role around the region. This has also transformed the culture around equity dividends in Asia. Emerging market companies paid a record $119bn in dividends last year, double their level in 2009, according to S&P Dow Jones Indices.

Chile, a well-known pioneer of pension reform, requires companies to pay out 30% of annual earnings, while Taiwan’s strong dividend culture – the average company pays out over 50% – is linked to historical government pension initiatives.

Traditionally a laggard in terms of dividend payments, South Korean has implemented legislation taxing excess corporate cash and providing incentives for companies that boost dividends, which have compelled companies such as Hyundai and Samsung to pay out 40-50% more in dividends in the last two years.