Asia's junk bond returns are lagging behind investment-gradedebt like never before as China's weakest projected growth since1990 and escalating leverage expose cracks across the region'seconomies.

Speculative-grade notes denominated in dollars have gained 2.76percent this year through May 9, 1.95 percentage points less thanhigh-grade bonds, according to index data compiled by JPMorganChase & Co. The underperformance is the worst over the sameperiod since at least 2005. Globally, returns were about even at4.1 percent, Bloomberg indexes show.

Increasing indebtedness in the world's second-largest economyand twin deficits in nations from India to Indonesia mean twice asmany Asian companies are facing rating downgrades this year thanthe average in the past decade, Standard & Poor's said on April28. With Chinese corporate debt more than doubling since 2009 to$2.01 trillion, yields that investors demand to hold Asian junkbonds are approaching a one-year high as Premier Li Keqiang saidmore defaults may be inevitable.

“My concerns about Asian high yield are focused on the pace ofprivate-sector credit growth,” Steve Drew, the head ofemerging-market credit at Henderson Global Investors, whichoversees about $126 billion, said by telephone. “It's createdpotential systemic cracks and heightened idiosyncraticvulnerability, particularly in China.”

Industrial production in China has fallen every month this year,the longest slump since October 2012, according to HSBC HoldingsPlc and Markit Economics. A property-market correction has begun asnew home sales tumbled and “every leading indicator turned down inthe first quarter,” Nomura Holdings Inc. said in a report May5.

China's economy will expand 7.3 percent this year, according toforecasters surveyed by Bloomberg. That would be the least sincegross domestic product increased 3.8 percent in 1990. China isaiming for 7.5 percent growth, which would be the slowest since1990.

On March 7, Shanghai Chaori Solar Energy Science &Technology Co. became the first company to default in China's $4.2trillion onshore bond market, while closely held Shanghai developerZhejiang Xingrun Real Estate Co. collapsed two weeks later.

“The underperformance is coming mostly from Chinese propertynames, and when you have concerns about that sector, you'd be aseller rather than a than a buyer,” Leong Wai Hoong, a moneymanager at Nikko Asset Management Co., said by telephone fromSingapore. “We're cautious.”

Nikko, which manages more than $160 billion, has held a smallerproportion of Chinese debt compared with benchmark indexes forabout two months, and is buying more higher-rated Asian debtsecurities, Leong said.

Evergrande Real Estate Group Ltd.'s $1.5 billion of 8.75 percentnotes due October 2018 have lost 9.3 percent this year. AgileProperty Holdings Ltd.'s $700 million of 9.875 percent notesmaturing March 2017 fell 3.2 percent in that time.

Some of the biggest U.S. banks are also recommending clientsretreat from Asian junk bonds. Goldman Sachs Group Inc. on April 4said investors should reduce overweight positions onspeculative-grade Chinese debt while Morgan Stanley last monthreiterated their view that investors favor higher-quality debt amiddefault risks among the region's weakest borrowers.

Record Sales

“The whole high-yield space in Asia is being driven by Chinarisk,” Neal Capecci, a senior fixed-income director at ManulifeAsset Management, said in an interview.

Asian companies are still poised to sell a record $150 billionof new debt this year, according to Morgan Stanley. At that rate,the size of Asia's dollar bond market will reach $1 trillion by2017.

Chinese issuers accounted for half of the $70 billion of U.S.currency debt offerings in the first four months of the year, withinvestment-grade notes comprising 80 percent of the total, the NewYork-based bank said.

Borrowers from Asia outside Japan issued $36.3 billion of U.S.dollar notes in April, exceeding January 2013 as the busiest monthon record by 60 percent, Bloomberg data show.

China Petrochemical Corp., known as Sinopec Group, raised $5billion in the region's biggest dollar-bond offering in a decade,while Cnooc Ltd., China's biggest offshore energy explorer, issued$4 billion of debt. Both are investment grade.

Cnooc's $2.25 billion of 4.25 percent, 10-year notes issued lastmonth traded at 100.5 cents on the dollar to yield 4.19 percentyesterday, according to Trace, the bond-price reporting system ofthe Financial Industry Regulatory Authority.

Expansion Moderating

“Credit risk is increasingly about funding, and the risks areincreasingly in the tail,” Morgan Stanley said in an April 29report. “Higher-quality credits are now actually improving whilethe weaker ones are deteriorating.”

Developing economies in East Asia will grow slower than forecastthis year as China's expansion weakens, the World Bank said in anApril 7 statement. India's rupee slumped to an all-time low inAugust while dollar-denominated corporate bonds tumbled 4.4 percentin their biggest rout in almost two years, reminding investors ofthe risks tied to economies which export more than they import andspend more than they earn.

“Rising current-account deficits have and will lead to furtherinterest rate rises, which in turn will put more pressure on Asiancredit growth,” Henderson's Drew said. “Increasingly leveredbalance sheets, coupled with slower growth and tighter credit, arethe hallmarks of a turning credit cycle going into late 2014.”

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