Asia credit market on the recovery path

Over the past two years, the return and volatility profile of the Asian high yield market has become less correlated with China real estate. There were even instances when the correlation turned negative, as shown in the rolling correlation chart below (Figure 2). The correlations between China's real estate sector and other major Asian high yield sectors, like those in India and Indonesia, have also similarly weakened. This is a noteworthy shift in market dynamics. Moreover, we have observed distinct performance divergences between the China real estate sector and other key sectors. This further indicates that the Asian high yield market has gradually returned to normalcy, no longer being skewed by the dominance of a single sector.

Figure 2: Asian High Yield sub-sector correlation to China real estate High Yield sector

Figure 3: Asian High Yield sub-sector performance

(2) Low default ratio expectation for 2025

After four years of market adjustments, the default cycle for China real estate is nearly over. Outside of the China real estate sector, other distressed issuers such as those in Sri Lanka have successfully restructured their debt and issued new GDP-linked bonds using a more sustainable debt structure, while Pakistani issuers secured adequate financing in 2024.

Our bottom-up analysis suggests a positive outlook for the future. We forecast a 2.0% default ratio for the Asian high yield market in 2025 on a market value basis. This is driven by the Chinese real estate sector, given a significant number of issuers are already trading at distressed levels. Furthermore, we anticipate that credit loss expectations to be close to zero, as most potential default candidates are already trading at distressed dollar prices close to their potential recovery values.

Currently, with China continuing to implement stimulus measures and most other Asian economies successfully recovering from the impact of the pandemic, credit fundamentals of the Asian high yield market are in excellent shape. This low expected default ratio in 2025 will serve as a strong fundamental factor that could drive Asian high yield spreads even tighter.

Figure 4: Asia High Yield market default ratio (2012 – 2024)

(3) Market sentiment and valuations are still lagging

Despite the market structure becoming more diversified and the Asian default cycle nearing an end, market sentiment and valuations are still lagging. This scenario could present an attractive investment opportunity in Asian high yield for the upcoming year.

As of the end of December 2024, the blended spread in the Asian high yield market stands at 521 basis points. This is notably wider than the historical normal range of 300-500 basis points observed before COVID and offers a significant spread pick-up over both US and European high yield markets. We believe the low expected default ratio in 2025 will drive Asian high yield spreads to tighten, possibly returning to historical norms.

Furthermore, the valuation dispersions across different sectors present potentially attractive credit alpha opportunities for active managers in 2025. This creates a fertile ground for those looking to capitalize on the unique dynamics within the Asian high yield market.

Figure 5: Asia High Yield historical spreads and yields

High yield credit market: Spreads

High yield credit market: Yields

The broader Asian credit market, with a market cap exceeding USD 1 trillion, is dominated by approximately 85% investment grade-rated bonds and about 15% high-yield rated bonds. Similar to the Asian high yield market, as the market structure diversifies, the Asian default cycle is almost over. However, despite this progress, market sentiment and valuations still lag behind.

This situation presents a unique and attractive investment opportunity in the Asian credit market, especially for investors with lower risk tolerance. Given the current market conditions, investors could consider diversifying investment portfolios and leveraging the potential this market offers.

Figure 6: Structural changes of broad Asian credit market

January 2020

December 2024

As a major segment of the Asian credit market, the Asian Investment Grade market offers an attractive spread pick-up of approximately 30 basis points. Additionally, it boasts a lower leverage ratio and a higher average credit rating compared to the US investment grade market. This combination of factors makes it an attractive investment option in our view.

Another noteworthy aspect of the Asian Investment Grade market is its average duration of 4.7 years, which is shorter than both the US and European investment grade universes. This shorter duration can be advantageous from a risk management perspective.

Taking into account both valuation and risk, we believe that the Asian Investment Grade market will continue to generate better risk-adjusted returns in 2025. It presents a unique opportunity for investors to achieve investment goals while effectively managing risk.

Figure 7: Asian Investment Grade historical spreads and yields

Investment grade credit market: Spreads

Investment grade credit market: Yields

Figure 8: Asian Investment Grade with stronger credit fundamentals than US counterparts

Net leverage: Asia Investment Grade (IG) vs US IG
Net leverage: Asia IG vs US IG

Average Credit Rating
(Upward migration for EM VS downward move for US credit)

The Asian Investment Grade segment, which currently encompasses over 400 different issuers, presents a significant opportunity for active managers to achieve alpha through diligent credit selection. The secondary market is notably liquid, providing ample opportunities for trading. Additionally, primary market activity remains robust, and we anticipate continued strength well into 2025.

Figure 9: New issuance volume for Asian Investment Grade

Trade conflict between the US and China

We believe a potential trade war would have minimal impact on Asian credit. Few Greater China US dollar denominated bond issuers export to the US, limiting exposure. An analysis of the 2018-19 trade war cycle indicates that the overall impact on Chinese exports was relatively minor. This resilience can be attributed to China's competitive manufacturing capabilities and robust supply chain, which were instrumental in mitigating any potential adverse effects.

Thus, tariffs are expected to have a minimal impact on credit spreads in China. China’s external position is very strong, and credit spreads are driven by ratings based on medium-term credit and macro credit fundamentals rather than tariffs. Moreover, US tariff announcements are seemingly used as leverage and negotiation tools for more favorable terms rather than the salvo to a full-blown trade war, latter of which could have a detrimental impact on the US economy and progress on keeping inflation in check . This reinforces our positive outlook on Asian credit.

Figure 10: Impact of trade war on China exports

Promising outlook for 2025

All in all, the Asia credit market is well on its recovery path this year, as the transformation of the high yield segment uplifts the broader market. Despite the still sluggish market sentiment and valuations, our outlook is positive, rooted in the market’s demonstrated resilience and growth potential. We believe Asian credit potentially offers a unique and attractive investment opportunity.