Tuesday, 18 June 2019

Debt Capital Markets: In search of yield

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The biggest challenge of any special report on Asia’s debt capital markets is usually finding a common thread among the region’s many individual bond markets. The latest report, however, comes with no such conundrum.

There is a clear driver behind the deals in Asia’s primary markets today, and that is the search for yield. From perpetual bonds in Singapore to subordinated Samurais in Japan and high-yield sovereign debt in Sri Lanka, investors are jumping at the chance to boost returns. As a borrower in Asia’s emerging markets, there can hardly be a better time to lock in low rates for the long term in the international markets.

Investors everywhere are finding it hard to make returns in an environment of diminishing supply and rock-bottom benchmark yields – and expectations of weak global growth mean that scenario is unlikely to change any time soon.

Since the UK voted itself out of the European Union, Industrial and Commercial Bank of China’s Hong Kong subsidiary has secured the world’s tightest coupon on an Additional Tier 1 bond, while Single B rated Sri Lanka managed to tighten its entire credit curve with its latest sovereign offering.

Across Asia, issuers are being rewarded with lower costs of funding even if their own fundamentals have worsened, or their economies are deteriorating. Such rash investing is here to stay, especially as it becomes more likely that the US Federal Reserve will hold off from raising rates until the end of the year. For the time being, higher returns will be increasingly difficult to capture.

To make things worse, a lack of new issues has inflated secondary prices in Asia, particularly in high-yield credit.

Yields everywhere are edging closer to zero, but, with negative yields becoming common in Japan and Europe, zero is no longer the bottom. In that context, even modest yields for risky credits may seem relatively attractive.

But this seller’s market could quickly turn. Once global financial markets calm down and the Fed’s rate trajectory comes back into focus, these expensive Asian credits could burn investors. Fund managers need to be mindful that they could be buying at the top.

Mark-to-market losses will become more severe as rates rise and yields follow, while Asian issuers will find it more expensive to repay foreign currency debt as the dollar strengthens. If that results in some issuers defaulting, current yields will not look like such a bargain after all.

There is no easy way out of this predicament. Bond arrangers are likely to remain busy for the foreseeable future, but Asian market participants know that global capital is notoriously volatile. Approach with caution.

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