* Investors seek junk as protection against rising rates
* Double-B now more correlated to Treasuries
* Spread products are scarce in Asia
By Christopher Langner
Feb 7 (IFR) - Asian investors have increased their holdings
of junk rated bonds in the past month partly to protect
themselves against higher yields for benchmark rates by
year-end. That strategy, however, may not work so well this time
around, analysts warned.
Asian markets saw more than US$12bn in sub-investment-grade
and unrated dollar debt issued in January, an absolute record.
Every transaction was several times oversubscribed amid pent-up
demand for the asset-class.
Credit analysts in Asia have partly attributed the spurt in
high-yield demand to managers seeking to reduce their exposure
to US Treasuries.
Traditionally, bonds with larger coupons move in tandem with
stock markets, while investment-grade debt follows US
Risk appetite and a strong economic backdrop often translate
into gains for stocks and junk bonds, while prices of US
Treasuries and German bunds drop, as well as most
investment-grade bonds that are benchmarked against them.
That move has already started as investors have become more
upbeat about the United States economy. The yield on the 10-year
Treasury spiked in January, closing over 2% on Monday for the
first time since April last year.
And while the yield has dropped back below 2%, the
1.95%-2.05% range it seems to be settling in is also 20bp wider
than the range in which it traded in December. Treasury
volatility has almost doubled in the past two weeks as well.
Stronger than expected employment data in the US last Friday
added to expectations that Treasury yields could end this year
This suggests the need to protect fixed income portfolios
against drops in the prices of low-coupon bonds, and Asian
investors seem to have elected buying high-yield as the strategy
to do so.
The problem, however, is that high-yield may not be such a
good alternative to seek refuge from volatile Treasury rates
The drop in yields of junk bonds has reached such an extent,
that their correlation may be closer to Treasuries than to
stocks now. "The view that 'high yield' is somewhat immune and
that the danger lies in high grade may be the wrong conclusion
at these historic 5%-6% yields for Double B credits," said Owen
Gallimore, head of credit strategy at ANZ.
The alternative, said one analyst, is to buy spread products
to offset potential losses from rate moves. Usually, when
Treasury rates rise, investment-grade bonds in Asia drop, but
not as fast as the benchmark. That means that the difference in
yield between these securities and Treasuries, or spread, is
Hence, the gains in five-year credit default swaps for
Indonesia, for instance, would partially offset losses in the
sovereign bond's price in the case of a Treasury yield spike. In
fact, in its outlook for 2013, Morgan Stanley predicted a 50bp
rally in average investment-grade spreads in Asia this year.
The problem, however, is that there hardly is any corporate
CDS in Asia, so investors are left only with sovereign contracts
to use as hedge.
While these contracts may reduce losses from a spike in
Treasury yields, they do not offer the recurring coupon payments
that high-yield bonds do. Therefore, given the options,
investors have shown that they prefer to hold junk bonds as a
That would usually work, but this may not happen in a time
when the average yield to maturity on the bonds that comprise
the Merrill Lynch Asian Dollar High Yield Index is at 5.94%, a
near record low. These days, high-yield are as close to
Treasuries as they have ever been.