China’s regional economies are still experiencing a relatively high growth rate, and issuers in the region have all come together to present a great income opportunity in Asian high yield, writes Henry Greene, investment strategist for KraneShares, in a white paper.

With the recent restructuring of Evergrande, investors’ concerns are being felt within the bond market in China; the KraneShares Asia-Pacific High Yield Bond ETF (KHYB) currently has an average credit rating of BB, but many of the securities within it are trading at “distressed levels.” This is providing investors the chance to earn price returns above the coupon payment.

Nikko Asset Management, a partner of ARK investment and one of the largest asset managers in Asia, actively manages the fund, and their first move was to divest the fund of positions in Evergrande long before the company signaled default.

KHYB currently has an average yield to maturity of 10%, and its annualized distributed yield is 7.74%, including recent months. Because of the way that the fund is structured, the portfolio manager Wai Hoong Leong reduced sector exposure in August and is now re-deploying cash into “quality China real estate issuers,” Greene writes.

Asian high-yield bond market spreads are up 122 basis points year-to-date but have been driven primarily by China’s market and Evergrande woes, whereas spreads in Hong Kong, India, and the Phillipines have all fallen. With the looming restructuring of Evergrande, some securities have traded at distressed levels, creating an opportunity for strong price returns beyond the fund’s monthly distributions.

A Look Ahead

The Fed has announced that it will begin tapering, creating the potential for rates to rise in the short term. KHYB currently has a low duration at 1.77 years, whereas in the U.S. it is 4.15 years and 3.17 years for the Asia ex-Japan benchmark; lower duration equates to less risk from interest rates.

Image source: KraneShares ‘KHYB: Adding Growth and Income to Your Bond Strategy’

“While we believe the market is already pricing in an aggressive rising rate cycle, it may take until 2023 to see the first rate hike in the US,” Greene says. “Against this backdrop, we believe Asia high yield bonds can provide meaningful income generation and less interest rate risk compared to US and other high yield markets.”

Central banks in Indonesia, Thailand, Malaysia, and the Philippines have all left policy rates as they were in September. That, along with the expectation that inflation will be lesser in some East Asian companies compared to the U.S., works to create a potentially lower-risk environment for investing.

“We believe KHYB currently offers an attractive income opportunity that has been compounded by the risk event of Evergrande’s restructuring. In addition to the fund’s coupon payment, investors may benefit from a substantial price return on bonds currently trading at distressed levels. Furthermore, the fund’s low average duration and significant exposure to China, which is unlikely to taper in the near term, mean it is well-positioned for a rising rate environment,” Greene writes.

The KraneShares Asia Pacific High Yield Bond ETF (KHYB) invests in USD-denominated high-yield debt securities from companies in Asia, excluding Japan. The fund is poised to capture the recovery and growth of the Asian bond market with the possibility of restructuring in the future as Chinese agencies begin to manage the risk within the markets.

By moving the credit curve up, KHYB will be more defensive against the benchmark and have shorter duration bonds than the index. When the bonds mature, Nikko can decide how and when it wants to redeploy and invest in new bonds, depending on market conditions.

KHYB carries an expense ratio of 0.69%.

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