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Not All Asia High Yield Bond Funds Are Created Equal

When investing in Asia high yield, investors should consider three key factors to help make an informed decision.

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.

The Author

Stephen Chang

Portfolio Manager, Asia

Naveen Gulati

Credit product strategist

Marcio Bogoricin

Head of Hong Kong and Singapore Global Wealth Management

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Disclosures

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PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.

The J.P. Morgan JACI Non-Investment Grade Index comprises fixed rate US Dollar-denominated high yield bonds issued by Asia sovereigns, quasi-sovereigns, banks and corporates. The existing JACI Non-IG contains both fixed and floating rate bonds issued by Asia-domiciled entities having a nominal outstanding of at least US$150 million and more than one year to maturity. It is not possible to invest directly in an unmanaged index.

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