Yield-chasing investors, whose hunger for income powered a long rally in Asian junk-rated bonds, are finally feeling the first symptoms of indigestion after a year-long binge.
The signs of excesses in the rally that left some junk bond holders with returns of 45 percent in 2012 are several.
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In the first week of the new year, investors put in an overwhelming $45 billion of bids for $1.75 billion of bonds offered by three junk-rated property firms from China.
But a more recent bond issue from Guangzhou R&F Properties was subscribed less than three times, while KWG Property withdrew its perpetual bond offering after it was covered just two times.
Alarm bells rang again when Chinese property firm Hopson Development Holdings Ltd. <0754.HK>, a company that is rated just four notches above default, raised money through 5-year bonds paying less than 10 percent, a rate less than half of what it would have had to pay a year ago.
KWG's cancellation was driven by investors' concerns that the bond issue was as risky as an equity investment, while a bunch of recent issuers have watched their bonds fall sharply in secondary market trading.
Even by themselves, these could be signs of an extremely frothy market taking a breather. But viewed alongside data showing investors globally are putting their faith in economic recovery and therefore shifting their cash back into stocks, they spell trouble for the yield junkies.
"Clearly the market is facing indigestion, especially due to supplies from property companies," said Arthur Lau, head of fixed income, Asia-Pacific at Pinebridge Investments.
The first weeks of 2013 have indeed seen a steady stream of bond issues by sub-investment-grade companies hoping to exploit the remnants of last year's desperate hunt for yield, including Hong Kong Broadband, Korea Development Bank, Cheung Kong Holdings <0001.HK> and Agile Property Holdings Ltd.
At the same time, investment-grade companies that supplied the bulk of 2012's record $133.8 billion of foreign currency bond issues have retreated somewhat since December.
A big reason for that shift has been the worry that even in a world of zero interest rates, top-rated bonds in Asia no longer adequately compensate investors for the risk of a spurt in U.S. Treasury yields, to which their coupons are benchmarked.
"There is not a lot of spread cushion left in our market, so if we do see a reasonably large shift in the U.S. Treasury market of say about 80 basis points, that would wipe out gains from a carry perspective in Asian yields," said Kaushik Rudra, credit analyst at Standard Chartered Bank.
It's a threat that has been steadily amplified by signs of improving economic growth in the United States and China, by the Federal Reserve's allusions to a quicker end to its aggressively easy monetary policy and, mainly, the avoidance at the start of the year of a massive automatic tightening in U.S. fiscal policy. Ten-year Treasury yields have risen 30 basis points in the past six weeks.
"Everyone is cautious on rates. The less rate-sensitive the credit, the better it is for investors," said Rajeev De Mello, a fund manager with Schroders.
"That may explain why high yield has got ahead of others. Plus it is also the yield environment where people are looking for higher yielding assets," he said.
Junk bonds, by virtue of their high yields, should offer a better spread cushion against that risk of a selloff in Treasuries, but the year-long rally had eroded the buffer.
Standard Chartered's Rudra doesn't have a big selloff in junk bonds as his base case, but warns that it wouldn't be an unrealistic scenario.
"Once you start seeing a shift, you could have momentum build up. A lot of people could start selling fixed income products in anticipation of bigger moves on the Treasury side and it becomes self-fulfilling," he said.
The interest in new issues could also be waning.
In the first week of the year, International Container Terminal Services received orders of $5.5 billion for a $300 million issue, Hopson received $6 billion of bids for a $300 million issue and Indonesian developer Lippo Karawaci's issue was subscribed more than six times.
But just a week later, KWG Property pulled a perpetual bond issue after attempts to woo wealthy retail investors with a rebate of as much as half-a-dollar on each bond failed to enthuse buyers. This compares with an average rebate of around 25 cents issuers used to pay to entice individual investors, in itself an indication of a change in sentiment.
Another property firm, Cheung Kong Holdings, got the same private wealth investors to pick up 60 percent of its perpetual bonds.
Plenty of investors have already decided this is an environment in which exposure to equities is possibly the better alternative to putting more money into junk bonds, whose riskiness is comparable to equities.
Data from funds tracker EPFR and other investment banks shows Asia ex-Japan equity funds have been attracting several times the flows going into the region's bond funds since November. In the week ended January 10, emerging market equity funds had record inflows of $7.4 billion, nearly four times that for debt funds.
The MSCI index of Asia ex-Japan stocks <.MIAPJ0000PUS) has climbed 6 percent since the end of November, compared with the just under a 1 percent rise in the high-yield JP Morgan Asian Credit Index (JACI) composite benchmark.
"Instead of chasing high single-digit yields in Chinese property bonds, one might as well invest in select equities or sell some options if that makes any sense," said Joshua Lee, Associate Director with Magenta Advisors, an investment management firm.
Selling put options, or options to sell stocks, could annually yield as much as 14 percent on blue-chip names, Lee said.
(Editing by Kim Coghill)