Dim sum (��) is known to many as a popular form of Chinese cuisine, comprising a wide assortment of small dishes served successively. The culinary art is believed to have originated from southern China, and the etymological root of this Cantonese term literally means "touch the heart." Originally intended only as a snack served by local teahouses to long-distance travelers and rural laborers, dim sum has evolved into a staple of Chinese dining culture.
The emergence of Asian credit as an asset class is analogous to the evolution of dim sum. While previously viewed no more than an hors d'oeuvre, Asian credit has progressively gained the attention it rightly deserves, thanks to structural changes in this asset class that have gathered momentum in recent years.Setting the Table
Let's briefly step back in time. Asian credit can trace its beginnings to USD-denominated sovereign bonds issued by the Philippines to global investors roughly two decades ago. Yankee debt issuance by quasi-sovereign credits in Korea, Malaysia and the Philippines, as well as a handful of conglomerates and banks in Hong Kong and India, soon followed through the early and mid-1990s. Access to international financing was confined to state-linked or large investment grade corporate issuers, however. Likewise, the investor base was narrow. Apart from the proprietary desk of international banks, Asian bonds were held predominantly by U.S. investment managers to supplement their Latin American debt exposure.
The Asian financial turmoil in 1997"“1998 dealt a huge blow to the region, with the impact exacerbated by the Russian default and the dotcom bubble shortly after. Still, the painful but needed policy stabilization program that emerged from the turmoil established a platform for the region's long-term growth. It was around the time of the post-crisis rebound that the first pan-Asia credit benchmark was incepted, marking the first step toward establishing Asian credit as an asset class. The Chase Asia Bond Index (CABI), the precursor to the JPMorgan Asia Credit Index (JACI), was introduced in August 1999. A month later, the HSBC Asian Dollar Bond Index (ADBI) was launched. The Asian credit market, when measured by market capitalization, has grown from $40 billion just a decade ago to close to $270 billion in December 2010 (see Chart 1).
Expanding Menus
As with dim sum, variety is now a hallmark of Asian credit.
In recent years, the asset class has expanded progressively to cover 15 fast-growing countries, with sovereign ratings ranging from AAA to Bâ?' (see Chart 2). Mongolia is the most recent entrant. Several other South and Southeast Asian nations are exploring the possibility of broadening their sources of financing. Importantly, at a time when industrial economies are experiencing downward pressure on their sovereign ratings, seven countries in the Asia-Pacific rim received rating upgrades in 2010. Currently, five countries and regions "“ China, Hong Kong, Indonesia, Philippines and Sri Lanka "“ have at least one positive outlook issued by one of the three National Recognized Statistical Rating Organizations (NRSRO), Moody's, S&P and Fitch.
Critically, the range of issuer types has broadened out, especially into corporate space. A decade ago, Korea alone accounted for almost half of the JACI, reflecting the dominance of its quasi-sovereign issuers. Today, Korea remains the single-largest issuer by country, but its index share has been cut in half and it now represents about one-quarter of the Asian market total. In 2010, there were almost 60 issuers "“ corporates and banks "“ that tapped the market for the first time. The asset class also saw the first corporate perpetual bonds launched last year, totaling over $3 billion. Significantly, the average size of investment grade issues has increased over time, with deal sizes of $1 billion no longer considered rare. All other things equal, larger issue sizes help boost secondary market liquidity.
Perhaps the most notable development in this asset class is the advent of high yield (HY) corporate issuers. Non-investment grade corporate bonds now account for 14% of total market capitalization in the JACI, up from less than 8% just five years ago. Their emergence reflects a confluence of factors that are unique to the current set of economic circumstances in Asia: rapid GDP expansion, broad political stability, an underdeveloped infrastructure, a move toward privatization and a growing need for funding flexibility.
Dominated by China and Indonesia, the HY corporate sector is also represented by issuers in Korea, the Philippines and Singapore. The emergence of a "Chinese property" subset is particularly striking, underscoring the rapid development of the housing market in China. Such bonds were non-existent prior to November 2005. Today, this subset constitutes over 40% of bonds issued by Chinese entities. On the other hand, robust commodity demand from China and India has benefitted resource-rich Indonesia, notably its coal producers. Sustaining industrial production would require significant capacity expansion in basic infrastructure. As the world's fourth most populous country and given a low penetration rate for wireless connection, cell phone demand will remain robust in the medium term. Not surprisingly, commodity, utility and telecommunication companies have dominated Indonesia's HY corporate issuance.
Significantly, the past five years have witnessed a few milestones for the Asian HY corporate sector. First, the average bond tenor has extended beyond the typical three to five years. Currently, there are at least six HY corporate bonds outstanding that mature in 10 years. Second, the individual deal size has increased to $500 million and above. Two HY corporate issues have an outstanding size of at least $1 billion. Third, unrated transactions have become more frequent. Last year, at least 10 deals were priced without obtaining credit ratings, primarily targeting local and regional investment managers.
Healthy Appetites
This brings us to the point of a wider sponsorship for Asian credits. While the U.S. remains a major source of investor interest, demand has rippled out to non-U.S. participants. This is amply depicted by an increased number of privately placed new issues, which are targeted exclusively at investors domiciled outside of the U.S. Arguably, the region has aroused the interest of global investors, prompting the search for alternative avenues of exposure.
For Asian investors, the financial turmoil in developed countries has served to galvanize the so-called "home region bias." Among the first movers are financial institutions and official agencies. More recently, retail and private banking flows into the asset class have seen buoyant growth. Apart from diversification benefits, individual investors viewed familiarity with issuers, particularly those that have successfully navigated through previous economic crises, as an added advantage. In the Philippines, the indigenous bid for its sovereign and corporate credits has been supported by flush USD liquidity that stems from overseas worker remittances.
As the world's economic center gravitates toward Asia, the hunt for greater investment exposure will continue. Returning to the analogy of dim sum, a strategic allocation to Asian credit is one way to "touch the heart (core)" of Asia. As with dim sum, there is the advantage of a dynamically growing spectrum of choices. You might pick the regular ones first, and then venture on to more exotic selections. Over the secular horizon, Asian credit spreads should tighten in tandem with improving fundamentals and ratings. Just as dim sum is best eaten hot, we feel investors would appreciate Asian credit at current levels, and as a way to express a constructive long-term view on Asia.
Past performance is not a guarantee or a reliable indicator of future results. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. The Quality ratings of individual issues/issuers are provided to indicate the credit worthiness of such issues/issuer and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody's, and Fitch respectively. Diversification does not ensure against loss. There is no guarantee that these investment strategies will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.
This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2011, PIMCO.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2010, PIMCO.
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