Deep and diverse: Welcome to today’s Asia credit market

Over the last decade, Asia credit has emerged as a trillion-dollar asset class with the depth and diversity necessary to become a core stand-alone allocation in investment portfolios — especially for Asia-based investors. While 2022 was one of the most challenging years since the market’s inception, Asia credit demonstrated resilience and lower volatility than past drawdowns while setting the stage for potentially attractive investment opportunities in 2023. Here we discuss some of the key features of the market, describe how these are likely to evolve, and make comparisons to other emerging market debt indices.

Figure 1

Asian credit market evolution

Growth of the market: The Asian credit market has grown from a market value of less than US$200 billion in 2009 to US$1.3 trillion at its peak in 2021. While market value shrank just below US$1 trillion in 2022 as a result of high yields and negative supply, Figure 1 shows that the size of the Asian credit market (as represented by the JP Morgan Asia Credit Index, or “JACI”) is comparable to some of the mainstream global fixed income indices, such as emerging markets sovereigns (EMBIG), emerging markets corporates (CEMBI) and US high yield (ICE BofA HY Constrained). Importantly, this growth has led to an increase in the breadth and diversity of opportunities available to investors in Asia. Thus, we believe the asset class is now a credible and compelling way to access Asia’s growth.

Figure 2

Positive rating migration with Asian credit universe: The underlying credit quality of the market is strong. Currently, only approximately 15% of the Asian credit market is rated below investment grade versus 40% more than a decade ago (Figure 2). Rating agencies have acknowledged the strong growth, fiscal discipline, and improvements in debt metrics for many countries, leading to sovereign upgrades. This has benefited Asian companies through lower financing costs and better access to capital.

Figure 3

Higher credit quality vs global EM indices (Figure 3): Companies around the world have taken advantage of low interest rates over the last decade to issue debt and increase shareholder returns. Rating migration has therefore been negative on average. Within emerging markets, there have been notable sovereign downgrades below investment grade. Since 2014, countries including Brazil, South Africa, and Turkey have lost their investment-grade ratings, in turn negatively affecting their quasi-sovereign and corporate issuers. By contrast, significant Asian markets such as Indonesia and the Philippines have been upgraded multiple times, placing them firmly in the investment-grade camp.

Strong local demand: Financial markets have deepened significantly in Asia over the past 15 years. In addition, there has been impressive wealth creation on the back of robust economic growth. High savings rates and strong banking system liquidity have generated structural demand for fixed income. Demographically, the region is also aging rapidly. This highlights the ongoing need for income solutions, ideally sourced from within Asia. This provides a strong investor base for Asian credit markets. Consequently, domestic Asian investors are the largest owners of the Asian credit market (Figure 4). The local investor base for Asia credit is broad, typically dominated by insurance companies, pension funds, commercial banks, asset managers, and private banks. This local technical support has repeatedly helped to subdue volatility when faced with global market sentiment shifts.

Figure 4

Market composition: The last decade has been defined by China’s dominance as a borrower in the US dollar-denominated market, growing from around 10% to over 50% of the total market value at its peak in 2021.¹ While Chinese issuers will remain an important part of the market, we expect lower Chinese issuance in coming years, driven by Chinese companies’ more modest global growth ambitions, cheaper funding costs in onshore markets, and a desire to reduce reliance on the US dollar. However, access to international capital will still be critical to the region’s future, and we expect continued growth in Asia credit issuance over the medium term. For example, meeting the area’s energy transition needs will require not only political will and vision but also external financing. These structural themes present potentially attractive opportunities for Asia credit investors.

Putting 2022 market performance in context

2022 was one of the most challenging years for fixed income investors globally and Asia credit was no exception. Calendar year returns for Asia credit, as measured by JP Morgan’s Asia Credit Index (JACI), were close to -11.0%, driven by higher US Treasury yields as well as widening credit spreads. Disaggregating JACI returns by credit quality, investment-grade issuers were down -10.0% while below-investment-grade issuers were down about -15.1% (Figure 5). The lower interest-rate duration of the Asia IG Credit Index allowed it to outperform US investment-grade corporate bonds and investment-grade-rated emerging markets sovereign debt.

Figure 5

The Asia HY Credit Index confronted many of the same challenges as other asset classes last year, with the added headwind of China’s property sector. Disaggregating returns for Asia HY Credit between China and ex-China, the Asia HY Credit ex-China returned -11% in 2022, in line with global high yield, while the same index with China included returned -21%. The performance of Asia HY credit with China was driven largely by the Chinese real estate sector, which returned -28%.

Outlook for 2023 and beyond

We believe Asia credit looks attractive. While macro uncertainty remains, for investors with a long-term orientation, investing in Asian credit markets may generate strong total returns. The major global central banks have reacted aggressively to elevated inflation, but we expect rate-hiking cycles to end in 2023, providing an upside to fixed income sectors with attractive spreads. While our overall outlook for Asia credit is favorable, we believe portfolio positioning will need to remain dynamic with rigorous focus on credit selection to identify opportunities and avoid value traps.

The overall JACI index was yielding close to 7.0% in late 2022, its highest yield level since 2010. This represents a dramatic repricing since the start of 2022 when Asia credit yielded 3%. Compared to other fixed income credit sectors, we believe this represents a historically attractive entry point for a relatively low-duration asset.

Lower new issuance will likely see negative net supply of Asia credit in 2023, even after the significant reduction in supply seen in 2022. As investor demand returns to Asia credit, attracted by high “all-in” yields and compelling return opportunities, constrained debt supply should provide additional technical support to the market.

¹Source: JP Morgan