It's getting harder to make easy money in Asia bonds as junk gets binned

Tokyo

IT'S getting harder to make easy profits in Asia's bond market as the trade war and geopolitical tensions drag down junk debt.

Speculative-grade bonds from the region have lost money for three straight weeks, their worst streak since late last year. That trend is threatening payouts for the rest of 2019, given that fund managers had loaded up on the riskier securities earlier this year.

Safer investment-grade notes are still making money, but as more investors now pile into those havens, sustaining strong returns there is also becoming more difficult.

"We are becoming increasingly selective within high yield, taking profits in the stronger year-to-date performers, and redeploying to more defensive, higher-quality sectors tied to government policy objectives and the Asian consumer," said Elisabeth Colleran, a portfolio manager on emerging market debt at Loomis, Sayles & Co. "The risk-off tone is clearly out there."

Investors have grown unnerved due to the recent flipping of the yield curve in the US, perceived traditionally as a precursor to a recession, and the ongoing tit-for-tat in the US-China trade war, along with weak economic data out of Germany and China.

While Asian dollar bonds have outperformed peers in other emerging markets, and have even seen inflows from some other regions, the market appetite that spurred record issuance in junk notes in the region this year is fading. To be sure, analysts have been quick to point out resilience in the region's dollar notes in previous bouts of uncertainty given the rising clout of wealthy Asian investors looking to put money to work.

And they aren't turning their back entirely on the asset class - just looking for protection in better quality. Asia dollar bonds mixed across credit ratings returned about 0.6 per cent last week, compared with a loss of 2.8 per cent on comparable Latin American notes, following a shock Argentine election result that hurt asset valuations.

The challenge in Asia now, though, is how to sustain what had been strong returns after the market rallied earlier this year following a slump in late 2018.

Riskier junk notes had been the easiest way to boost performance when the market was hot, but that engine is now sputtering.

Moreover, the recent gains in investment-grade securities have been helped by a sharp fall in Treasury yields, which could be hard to sustain.

Investors will be focusing on a planned address from Federal Reserve Chairman Jerome Powell's at the annual central banker policy symposium in Jackson Hole, Wyoming on Aug. 23, as expectations of a September rate cut grow.

If the Fed doesn't cut as expected, risk assets are likely to face a beating, according to Ajeet Choudhary, executive director for fixed income at JPMorgan Private Bank in Asia.

Here's what market watchers are saying: "The slowing growth environment is less favourable for high yield," said Angus Hui, head of Asian credit and emerging-market credit at Schroder Investment Management.

"As yield from high-quality assets continues to fall, investment-grade spreads will become more attractive, and the majority of investment-grade credits are less sensitive to economic downturn."

While expectations of lower interest rates should also support junk credits, some lower-rated issuers have much more financial flexibility than others, making selection key, Mr Hui said.

Asia's corporates have "slashed leverage metrics meaningfully in recent years and are well-positioned," according to Loomis' Ms Colleran.

"No shortage of stress signals with treasuries trading lower, dollar strength, Argentinian election panic, European bank stress, and the weak China macro data and negative trade headlines," said Owen Gallimore, Singapore-based head of credit strategy at Australia & New Zealand Banking Group Ltd.

Asia investment-grade dollar bonds will probably outperform high yield for the remainder of the year, as managers "will want to lock in already solid returns" for the latter amid growing uncertainties, according to Todd Schubert, head of fixed-income research at Bank of Singapore. BLOOMBERG