Pimco Wary on Asia Junk Debt as Slowdown Hurts Company Profits

Pimco Wary on Asia Junk Debt as Slowdown Hurts Company Profits

Investors should be wary of high-yield borrowers as slowing growth in Asia threatens profitability, according to Pacific Investment Management Co., manager of the world’s biggest fixed-income fund.

Companies in Asia outside Japan almost tripled junk bond sales to $19.2 billion this year compared with $6.85 billion during the same period in 2012, data compiled by Bloomberg show. China’s economy will slow to average 6 percent to 7.5 percent annual expansion during the next five years from 9 percent the past five, weighing on the region’s growth, according to a report from Newport Beach, California-based Pimco.

“The slow-growth landscape favors higher-quality credits and warrants caution on higher yielding names that could become impaired in an environment where profits will be challenged,” Tokyo-based Tomoya Masanao, the head of portfolio management for Japan, wrote in the report due for release today. “The emphasis should move away from risk assets that have benefited purely from the central bank liquidity wave in which valuations have become detached from fundamentals.”Investors redeemed more than $6 billion from high-yield bond funds in the week to June 5 and fixed-income funds posted their biggest weekly outflows on record amid speculation the Federal Reserve may slow asset purchases, which have fueled flows into emerging markets, data from EPFR Global show.

Long Treasuries

Treasuries are “the place to be,” Bill Gross, Pimco’s co-chief investment officer, said June 6, after raising holdings of U.S. government debt in his Pimco Total Return Fund (PTTRX) to 39 percent as of April 30, the highest level since July 2010. Gross predicted the three-decade bull market in bonds probably ended at the end of April.

Yields on speculative-grade notes from companies in emerging markets in Asia fell to an all-time low of 6.38 percent last month, helping to boost issuance, before surging almost one percentage point to 7.48 percent as of June 7, according to Bank of America Merrill Lynch indexes.

High-yield bonds, also known as non-investment grade, speculative-grade or junk, hold ratings lower than BBB- from Standard & Poor’s and Fitch Ratings Ltd., or the equivalent Baa3 from Moody’s Investors Service.

Limits Reached

Bharti Airtel Ltd. (BHARTI), the second-largest issuer of junk notes in the U.S. currency in Asia this year, missed analyst estimates last quarter as net income plunged 49 percent after a weaker rupee raised interest payments and prices for network equipment.

Companies from China and Hong Kong have dominated sales, accounting for 59 percent of the region’s dollar-denominated junk bonds since Dec. 31, data compiled by Bloomberg show.

Net exports and investment that previously fueled China’s growth are reaching their limits, according to Pimco’s report.

“Prospects for export-led growth are inhibited by China’s large size in a global marketplace that remains deficient in aggregate demand due to high indebtedness in the developed world,” Ramin Toloui, Pimco’s global co-head of emerging-markets portfolio management, said in the report. “Investment cannot play its previous role in driving growth because it’s already risen to almost 50 percent of gross domestic product, up from 35 percent in 2000.”

Lending in China is also having less of an impact, with each $1 of new credit generating about 20 cents on average of GDP, versus 60 cents before the financial crisis, according to the report.

‘New Normal’

“China’s economy needs to shift to greater reliance on household demand,” Toloui said. “Latent demand for not only consumer goods but also services such as health care is likely enormous. However turning that potential into reality requires changes in economic policy that are wide-ranging and difficult.”

In Australia, a “new normal” will arrive, characterized by slower growth as the intensity of Chinese policy stimulus subsides and expansion outside of the South Pacific nation’s mining sector remains subdued.

“This economic backdrop implies a ‘new neutral’ level for policy rates, which we believe should be lowered from 5.5 percent to about 3 percent, which takes into account higher end-borrowing rates, an elevated Australian dollar and lower potential growth rates,” Robert Mead, Pimco’s head of portfolio management in Australia said.

As such, Australian government bonds should be “a relatively attractive asset for high incomes and capital gain potential,” according to Pimco.

To contact the reporter on this story: Rachel Evans in Hong Kong at revans43@bloomberg.net