Sidestepping EM risk in global high yield

A bias towards developed markets within the high-yield sector has been well rewarded in 2021, as Brent Finck explains.

Sidestepping EM risk in global high yield

In recent weeks, global high yield investors with exposure to emerging markets have grappled with volatile price action and widening yields. Much of the concern is concentrated in Asia, spurred by the unfolding story around China Evergrande Group, the country’s second largest developer with debt of over $300 million. Uncertainty around the future of the gambling industry in Macau, which has been hit hard by travel restrictions due to COVID-19 and the prospect of stiffer regulations, has added further pressure.

As shown below, a benchmark Asia high yield index posted a year-to-date total return of -5.60 per cent as of September 30, 2021, significantly lagging the global high yield index return of 4.54 per cent. Similarly, yield-to-worst in the Asia high yield market has widened more than 380 basis points (bps) to 10.61 per cent, while the global high yield segment has tightened nearly 30 bps to 3.65 per cent.

Figure 1: Year-to-date yields, spreads, and total returns for high yield benchmarks
Year to date comparison figures, yield, spread, and total returns
For illustrative purposes only. Past performance is not a reliable indicator of future results.
Source: Bloomberg, data as of October 15, 2021
Figure 2: Year to date evolution of the yield to worst (per cent)
For illustrative purposes only. Past performance is not a reliable indicator of future results.
Source: Bloomberg, data as of October 15, 2021
Figure 3: Total trailing year to date total returns (per cent)
For illustrative purposes only. Past performance is not a reliable indicator of future results.
Source: Bloomberg, data as of October 15, 2021

The current situation presents an opportunity to examine the challenges of managing emerging-market risk in a global high-yield portfolio. In the pursuit of superior risk-adjusted returns, our approach to global high yield is differentiated by our sole focus on developed market credits. This strategy is, in part, founded on our belief that sovereign risk is inherent in emerging markets – a reality that we are seeing play out with Evergrande and Macau.

Evergrande – too big to fail?

After skipping coupon payments on two occasions in September, the Chinese property developer has set the clock ticking on 30-day grace periods before its non-payment constitutes an official event of default. Many market participants see the missed payments as a prelude to a complex restructuring of the group’s $300 billion-plus liabilities, including over $19 billion in outstanding US dollar-denominated bonds, which would likely result in a loss to some stakeholders. Negative sentiment surrounding Evergrande is spilling over to the broader Asia high yield market amid growing concerns about the health of China’s heavily indebted property industry and potential contagion to financial systems in China, Asia and beyond.

Is Evergrande too big to fail? Investors are left wondering to what extent the Chinese government will become involved and what it will mean for offshore bondholders – a clear indication there is sovereign risk associated with Evergrande and the Chinese property sector. Investors must consider potential policy interventions and the personal agenda of Chinese President Xi Jinping alongside government efforts to reshape China’s society and economy, all of which are fluid and, to some extent, unpredictable. (See: Regulatory shifts in China: A new fork in the road?).

To date, Beijing has signaled a willingness to support homebuyers and taken steps to ease liquidity in the financial system; however, it remains unknown if the government will pursue a direct bailout of Evergrande, oversee a restructuring or just try to ring-fence the troubled firm and contain contagion. In our view, this is not a favorable risk-return environment for global high yield investors. As such, we have no exposure to Evergrande or Chinese property companies.

Hold or fold? Deciphering Beijing’s intentions in Macau

In the pre-eminent gambling hub of Macau, government officials recently launched a public effort to amend gaming laws ahead of the expiration of casino licenses next June. Many investors expect a significant regulatory crackdown on the industry, which may include measures such as direct supervision of casino operators by government representatives.

Licenses are a particular point of interest. While current licenses were issued for 20 years, new licenses are expected to be shorter. Some existing operators may lose their licenses altogether, and those who are granted new licenses will face greater uncertainty associated with shorter terms.

A market-only approach seems necessary to generate attractive risk-adjusted returns

Although many of the operators in Macau are domiciled in the US and therefore within our domestic market purview, we consider the risk of the casino operators in question to be primarily oriented toward emerging markets, given their reliance on Macau for a large portion of their revenue. As with Evergrande, we believe investors in Macau are taking on sovereign risk as Beijing’s drive toward a vision of “common prosperity” creates uncertainty. Consequently, we have no exposure to Macau casino operators.

In summary, a differentiated, developed market-only approach to global high yield seems necessary to generate attractive risk-adjusted returns across a full spectrum of market environments – including the current challenging situation in Asia.

Want more content like this?

Sign up to receive our AIQ thought leadership content.

Please enable javascript in your browser in order to see this content.

I acknowledge that I qualify as a professional client or institutional/qualified investor. By submitting these details, I confirm that I would like to receive thought leadership email updates from Aviva Investors, in addition to any other email subscription I may have with Aviva Investors. You can unsubscribe or tailor your email preferences at any time.

For more information, please visit our Privacy Policy.

Important information

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

In Europe this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK Issued by Aviva Investors Global Services Limited. Registered in England No. 1151805.  Registered Office: St Helens, 1 Undershaft, London EC3P 3DQ.  Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material.  AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1Raffles Quay, #27-13 South Tower, Singapore 048583. In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom. Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager. Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”).  AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.

Related views