The size of the external Asian credit market has more than doubled over the past five years. Having grown from approximately $500 billion at the end of 2013 to $1.2 trillion as of April 2019. Asian credit is now comparable in size to the US high-yield market.
Asian corporates now account for 53% of the total global stock of emerging market (EM) corporate debt. Indeed, the value of dollar debt from Asian corporates is greater than that of Latin America, Europe, the Middle East and Africa combined. Over the past five years, Asia accounted for 90% of the total growth of the external EM corporate debt stock globally.
The fact that Asia’s external corporate credit market has become this size should not be surprising. Asia is home to half of the world’s population and half of the world’s foreign currency reserves. At market exchange rates, Asia is home to three of the top seven global economies by GDP. Meanwhile, China and India are growing at far faster rates than any of their peers in the top 10. Asia contributes 30% of global GDP but, given the disparity in growth rates, this could hit 50% by 2050. The IMF forecasts that emerging Asia’s combined GDP will surpass the US in 2020.
Structural underallocation to Asia
Despite Asia’s size and attractive growth, global investors are structurally underallocated to the region. One significant reason is that key market indices understate the size of the Asian US dollar credit market. Examples of the relatively modest weight Asia receives include:
- Asia weight in the ICE BAML Global Corporate & High Yield Index = 5.2%
- Asia weight in the ICE BAML Global High Yield Index = 6.7%
- Asia weight in the JP Morgan CEMBI BD = 36.8%
The structural underallocation is exacerbated by global investors using Asia as a funding source, maintaining underweight positions in Asia relative to their benchmarks to fund overweight positions elsewhere. A recent illustration of this point is visible in JP Morgan’s monthly investor survey (April 2019). Here, the average positioning of 200 investors managing over $1 trillion in EM assets (dedicated and crossover investors) revealed the group had underweight positioning in every Asian country. Our team consistently meets with strategists to gain insights and evaluate shifts in global attitudes toward Asia. Though the evidence is anecdotal, the underweight positioning has been, and remains, a consistent theme.
Technical market factors play an important role in Asian credit. The combination of the structural underallocation from global investors and the ample FX reserves in the region translates to over 80% local ownership of Asian US dollar credit – the highest such ratio for EM markets globally.
Such high local ownership means that local factors, such as economic health and regulation, are often more important market drivers than global investor sentiment. This results in Asian credit having relatively lower correlation to US markets – a critical consideration for global investors looking to optimise their portfolios. We have seen Asian correlation to US credit decline over the past several years. We expect correlations to remain lower, as economies like China and India continue to mature and transition to domestic consumption from low-quality export models.
Fundamentals and valuations are attractive
At BBB+ average rating, Asian credit is the highest credit quality EM asset class available to dollar investors. Furthermore, Asian corporate issuers expose investors to lower leverage than similarly rated US peers across the credit spectrum. There has been a meaningful divergence in credit quality between US and Asian issuers since 2015, as measured by net corporate leverage. With the rising concern about BBB issuers in the US, Asia’s corporate balance sheets are healthy and in a better position to navigate a turn in the cycle or unexpected shocks.
The last piece of the puzzle is valuation, which remains attractive for Asian credit. There are many ways to think about valuation, but one of our favourites is to compare spread per turn of leverage. Asian credit historically offered investors an attractive premium, on average around 60% higher spread per turn. Current valuations are even more attractive than the long term average, given Asia’s wider spreads and stronger fundamentals.
Summary
The Asian credit market is too big to be ignored by global investors. With strong fundamentals, attractive valuations and decreasing correlations to US credit, global investors should be capitalising on the opportunities in Asian credit. Unfortunately, structural underallocation remains the status quo and many investors continue to miss out.
Paul Lukaszewski – Head of Corporate Debt Asia and Australia, Aberdeen Standard Investments
