Ensuring Yield in Volatile Times

Pheona Tsang, Head of Fixed Income

Pheona Tsang, Head of Fixed Income

It is no surprise why Pheona Tsang, the fund manager for BEA Union Investment Asian Bond and Currency Fund and her boutique team have kept a five-star rating year after year and the best-in-class in the highly competitive Asian Fixed Income Category.  Her focused and highly disciplined portfolio held her undistracted amidst market turbulence. Tsang shares with BENCHMARK how she managed to return her investors with rewarding yield while the market actively hunts.

BENCHMARK: Pheona, you run a portfolio with relatively high conviction. What is your house philosophy and what are the major criteria for an issue to fall under your radar?

Pheona Tsang:  We integrate both top-down macroeconomic and bottom-up credit research when constructing our portfolio.  From a macro perspective, we conduct a comprehensive forecast of interest rates, monetary policy stance, currencies and credit spreads of key Asian countries, the U.S. and Europe.  For bottom-up selection, we first start by excluding, using high yield bond as an example, all potential issuers that are not publicly listed, with an issue size below USD150million, illiquid, and financial information not readily accessible. For every issuer/issue, we assign an internal credit rating based on forward-looking cash flow forecasts, comparison of creditworthiness between issuers in the same industry, and adjustments due to parental/government support. The process has helped us identify potential pricing errors in the market.

BM: So, how do you assess credit worthiness and how is fair valuation defined?  

PT: For each industry, we run a regression analysis to compare the credit spreads amongst all the issues to ascertain a fair valuation. This process helps us identify undervalued issues.  Our credit strategy also calls for a rigorous credit analysis on the targeted issuers to decide whether they are in the high grade or the high yield bucket. We do not only rely on credit agencies’ ratings, but we assign an internal credit rating for all the issues that we invest in whether they are secondary or primary issues. Our proprietary credit scoring system is based on the methodology of Moody’s which focuses on industries such as property, port, oil & gas, airport, manufacturing, telecom and steel.

As to defining fair valuation, we have our “Fair valuation” model that calls for screening of criteria.  Our peer selection screen issuers within the same industry, country, credit rating and maturity tenor.  Our regression model runs the valuation curve of the securities with the same characteristics as mentioned; Fair valuation of the credit spreads is obtained for each securities; and finally value opportunity, where we buy or sell bonds that are undervalued or overvalued after incorporating credit and liquidity consideration.

BM: How do you look at risk and what is the model for control? 

PT: Effective risk control is a critical consideration during our portfolio construction process. Our internal credit model doesn’t only include historical financial analysis but also forward-looking business or cash flow adjustment. Apart from what has been mentioned earlier about our internal credit rating system and specific investment guidelines and restrictions, there are also self-imposed risk alerts policies, such as a 6% single issuer position limit and +/- 1-year portfolio duration against the benchmark. Deviation from these risk alerts is only allowed for tactical positions with a disciplined exit at pre-set target prices and a target stop-loss in any position.  Allocation deviation to country, sector, credit rating, maturity, duration and yields are also carefully monitored.  We do not aim to eliminate risks, but we understand where and what risks we are taking, in pursuit of the expected returns on our best investment ideas.

BM: What happens when an issue is being downgraded?

PT: Credit downgrades have proven not to be a surprising event to us, as we position ourselves with appropriate sell actions way ahead for those bonds potentially demoted to non-investment grade bonds for portfolios that are supposed to invest in investment grade only. In the case of an actual downgrade or breach of guidelines, we will sell the bonds at the best prices available.  The exit of all holdings in Kaisa Group before its bonds being downgraded and subsequent investor exodus, best illustrates the robustness our assessment process.

BM: How benchmark-conscious is the team and what are the parameters being implemented? 

PT: We consider ourselves benchmark-conscious, however, with maximum allowable flexibilities.  The Fund under such flexibilities are given in picking bond issuers’ credit rating, whether investment grade or non-investment grade; sectors and types whether government or corporate, coupon-paying, zero-coupon or convertible bonds; maturity and duration for long or short-dated; industries and countries, where no more than 30% are in non-Asia issuers; and currencies. The flexibilities are important, as, the performance of high yield bond was good in 2015, with a return of 5.8%, while investment grade was 2.7%.  Within Asia, performance is quite diverse.  For example, the China property high yield bond returned 15%, while Indonesia it was -2.8% and -16% for India.  In such a case, the fund performance will depend on the country allocation decision by the fund manager.

BM: The Fund, although categorized in the Asian Bond bucket is no doubt China bias and has a heavier tilt towards property companies. What is the rationale and are you worried about China’s overcapacity issue?

PT: So, over 50% of the Asia High Yield Index are Chinese companies, in which Chinese property accounts for 39%.   The Fund will keep overweighting in the Chinese property sector as we expect a stable return while also be able to find opportunities in the commodity sector. The property sector is still an important growth driver in China, and I believe we still have a 10% growth in the sector for this year.  We feel that the continuous slowdown in the Chinese markets will have more impact on the equity market than the fixed income market.  As for overcapacity, the issue from two years ago where China raised mortgage rates making it difficult for property investment. The government has now offered policies to ease, such as unwinding home purchase restrictions, lowering down-payment ratios and loosening policy for foreigner-buyers in Chinese property, etc.  For tier one cities, inventory has been de-stocked to the level of 2010 whereas tier two cities destocking is continuing with their 30 months of inventory.

BM: Do you expect the main driving themes for the portfolio to be monetary policy divergence, and what are the impacts to the rest of Asia? 

PT: We are positive on China’s monetary policy. With the easing monetary measures in China, we prefer interest rates sensitive sectors, such as property which would benefit from the rate cut and underweight industrials which are affected by overcapacity issue. Although there are concerns regarding the U.S. interest rate, we do not expect to see further and bigger impact in the markets. The marginal effects of the USD strength will be faded out by the end of 2016. Likewise, we may see further corrections in Asian markets to fade out too.

Asian countries have tried to stimulate the local economy through fiscal policy on top of their monetary policy.  China, for example, may have interest rate cut further, something the market has already factored in, Indonesia also had cuts and planning for another one in the second quarter of 2016.  Malaysia and India will follow suits and take similar measures.

BM: Do you expect further reform with the SOE and will it potentially heighten volatility in space? 

PT:  We consider there are different tiers of SOE about central government, provincial government and local government. We are optimistic about the SOE reform as it will result in more profit oriented companies and we are positive in the long term.

BM: The Fund has little exposures in the rest of Asia.  Do you see that changing?  What do you think about the hotspot Indonesia and India?

PT: For the rest of Asia, both Indian steel and Indonesian property could be strong performers. The steel sector has suffered from over capacity issue, but the Indian government imposed import duties, and we now see value in the sector.  In regards to the Indonesian property sector, the market has corrected so much due to the concerns on currency last year, and some are being traded at 7-10% yield.  The industry should be supported by the easing monetary policy from the government, and most developers have achieved decent marketing sales. We think they are very attractive to invest and would wait to invest in the oil and gas sectors until the markets calm.

BM: How is the Fund hedging against currency risk, and what is your exposure at the moment? 

PT: The Fund has high currency exposure in USD, but we would consider adding Asian currencies after the USD strength peaks out, expectedly by the end of the first half of 2016.    We find Indonesia to be very attractive among other Asian currencies from our review of both currency investments and bond yields.  The interest rate for Indonesian rupiah is 8% while it is 4% for Malaysia and 2% for Korea.    After the correction of Asian currency market, the Fund has allocated 5% of the portfolio to tactical trading in Asian currencies including Indonesian rupiah and Malaysian ringgit during the third quarter of 2015. BM