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Brent FinckGlobal Co-Head of High Yield @BrentFinck
A bias towards developed markets within the high-yield sector has been well rewarded in 2021, as Brent Finck explains.
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
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.
