Many investors have exposure to Asia high yield bonds, whether through mutual funds or holdings of individual securities. However, the universe is diverse and performance tends to be uneven and differentiated across credit sectors, industries, and individual companies. We believe there are three key factors to consider when investing in Asia high yield bonds.
Consider the benchmark
For mutual fund investors, the fund’s benchmark is not only a good way to compare a manager’s performance versus the market, but it also should help in assessing their approach to risk management.
Depending on an asset manager’s views, funds will typically be underweight or overweight a company, sector, or country compared with their benchmark, hold tactical exposure to securities not in the benchmark, and potentially avoid a security in the benchmark altogether. These positions will affect the portfolio’s overall volatility and returns.
If a fund’s benchmark is engineered to include asset classes outside the Asia high yield market, the resulting fund’s composition, risk and returns might start to deviate from the asset class the investors intended to allocate to. For example, some Asia high yield funds have benchmarks that are closely representative of the Asia high yield market as a whole, e.g., the JPMorgan Asia Credit Non-Investment Grade Index (JACI Non-IG Index). More custom fund benchmarks can materially differ from the Asia high yield market. For example, they could include investment grade securities that increase duration and alter the overall risk profile, or alternatively, include only a subset of the Asia high yield market. As a result, it’s important for investors to understand a fund’s benchmark and the types of risks they may be exposed to.
Understand the opportunities in unrated bonds
Many investors buy individual Asia high yield bonds based on their knowledge of certain companies, sectors, and countries. In doing so, they often rely on rating agencies to help make investment decisions. However, a significant part of the Asia high yield market is unrated, not because the unrated issuers are all of poor quality, but rather because historically these issuers were able to raise debt financing without an agency rating, so saw only incremental benefit in attaining one. In fact, nearly a quarter of the JACI-Non IG Index is currently unrated.
In our view, these unrated bonds provide a significant opportunity for those with independent and skilled credit research capabilities to find securities that are mispriced relative to their fundamental value, while still being selective. At PIMCO, we have identified a significant number of opportunities in unrated securities.
Don’t let yield-to-maturity be your only guide
Yield-to-maturity (YTM) is only one factor contributing to a fund’s performance. However, many investors rely heavily on this metric when making allocation decisions, investing more in funds that have a higher published YTM. As a result, they may find themselves invested in funds that are riskier than they expected, and with potentially lower all-in returns after considering the impact from defaults, or callable bond features (bonds that can be redeemed or paid off by the issuer prior to maturity).
In our view, an investor in the Asia high yield market should be most focused on the total return a fund earns over time. Total return includes not just the fund’s yield, but also potential capital appreciation or depreciation from events such as rating upgrades and downgrades, defaults, and excess returns added through security selection. Security selection includes not just a decision about investing in one company compared with another, but also which specific bond to buy within a company’s capital structure, since many companies issue multiple bonds.
Investors should also focus on a fund’s total return versus its benchmark return. This represents a manager’s alpha, or excess return relative to the market in which it’s investing.
Bottom line: understand and manage your risk to capture value
In today’s ultra-low rate environment, many investors are being drawn to Asia high yield given its compelling valuations. There are many Asia high yield bond funds available, and investors should ensure they fully understand the opportunity set as well as the risks related to their investment choices. It is important to focus on maximizing total return over the long term, and not simply owning the highest yielding securities in an index.