Asian junk remains hot amid volatility

Fri Mar 22, 2013 3:41am EDT

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By Christopher Langner

March 22 (IFR) - The combined order book of US$13bn for US$1.385bn of new bonds from four junk-rated issuers yesterday showed that the Cyprus bailout crisis has done nothing to dent investors' appetite for risky Asian credits, even with yields near record lows.

The four issues came only days after Cyprus rejected the onerous terms of an international bailout, leaving its banking system on the brink of collapse and raising the risk of a first exit from Europe's single currency.

The VIX Volatility Index spiked to around 14 and stock markets remained under pressure all week as investors waited for a resolution.

Still, demand for Asian high-yield asset class has grown. The reason for this is simple: "High-yield is the best place to invest right now," said a credit analyst in Singapore.

The statement was proven in numbers. Indonesian developer Alam Sutera, rated B2/B, sold a US$235m seven-year non-call-four Reg S/144a bond to yield 7.25% on orders of US$4.5bn. Another developer from the Philippines, unrated Filinvest Development, priced a US$300m 2020 bond at 4.25% after drawing demand for US$1.5bn.

Star Energy Geothermal, rated B2/B+, attracted orders of US$4bn for a US$350m paper sold at a 6.125% yield. Bank Rakyat, split rated at Baa3/BB+, sold a five-year Reg S at a yield of 3.125% after getting orders of US$2.65bn.

One private banker in Singapore explained the counterintuitive demand by saying her clients were shunning low-yielding government securities. As for equities, they still remember losses incurred during the 2008 crisis and they do not like the volatility that goes with the asset class.

RISKY BUT STEADY

Indeed, year to date, the JP Morgan non-investment-grade Asian Credit Index (JACI) has seen a maximum close-to-close volatility of 3.7% on the 10-day moving average. Meanwhile, the same measure for the Hang Seng Index has hit 18.5% this year and has not fallen below 5%. The same reading for the S&P 500 index recently peaked at 19.25% and the index's lowest volatility in 2013 was 3.88%.

For a graphic of the volatility in the non-IG JACI vs the Hang Seng Index please click on this link: reut.rs/YqbSLE

The volatility in equities is especially worrisome for private banking accounts and hedge funds, which, in Asia, have been making increased use of leverage. For those using borrowed money to invest, the predictability of return is very important, since brokers trigger margin calls if the value of the assets falls a certain amount, usually around 10%.

While such swings are not uncommon in the equity markets, they occur much less often in high-yield credit. On March 4, for instance, trading in the shares of most Chinese developers was halted in Shanghai as the property sub-index dropped 10% in one day. Meanwhile, the dollar bonds of the same companies, most rated below investment-grade, dropped less than 1.5%.

Fixed-income investments also offer a better chance of recovery in case the company gets into financial trouble because bondholders have precedence over shareholders in liquidation proceedings.

Investors remain upbeat about the potential for returns from the sector, in spite of the strong performance logged recently. The non-IG JACI has returned 14.4% in the past 12 months, and the average yield on the index dropped to one of its lowest levels of all time at 5.73% last week, at the same time as the average maturity on it was extended to 9.7 years.

Yet, a high-yield portfolio manager in Chicago said that, while yields on US junk bonds were at all-time lows, their spread over Treasuries - another preferred measure of risk - was hovering around 500bp, well above the all-time low of near 260bp. Default rates were at recent lows, which added to the safety of the investment, said the portfolio manager.

Nevertheless, for all the apparent advantages, Asian investors may be taking a rosy view of the asset class and piling on more risk than they realise. After a strong run in the past two years, prices of junk bonds are more likely to drop than to rise, while default rates may rebound from historical lows.

Being atop the capital structure may bring little advantage, either. Most high-yield bonds in Asia are from China or Indonesia, where bankruptcy procedures are unpredictable.

Yet, as one private banker in Singapore said: "If you can afford to hold these bonds to maturity and you are comfortable with the credit, they are the best you can get now." (Reporting By Christopher Langner; Editing by Steve Garton)

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