Asian bonds back in focus as end in sight for rising rate environment
Fixed-income and multi-asset fund managers believe Asian fixed income markets are more appealing today than they have been in the past 12 months driven by attractive valuations after repricing.
“Given that our scenario is that we are close to the end of the move in terms of a rising rate environment, we should be prepared to consider investing in fixed income markets due to valuations,” said Jerome Broustra, head of investment specialists, fixed income and multi-asset solutions at AXA Investment Managers.
“We feel that the repricing of the fixed income market is probably close to an end, and in the fourth quarter it should be stabilising and normalising,” he told AsianInvestor, noting that such an environment should make markets that can provide for more attractive valuations stand out.
In the fourth quarter, the investment arm of AXA thinks US high yield, or inflation-themed bonds, and green bonds, would be the top choices. Meanwhile, Asian fixed income also offers good opportunities.
Asian sovereigns appear to be better placed under the current macro backdrop, because they've proven resilient in terms of domestic activity and they have relatively modest debt burdens and good reserves, Broustra said.
“We also prefer high-quality credit ... so it's Korean state-owned enterprises (SOEs), Singapore and Hong Kong banks, for instance. It's because these sectors have demonstrated resilience in historical sell-offs given their strong rating and stable fundamental profile,” he added.
The team also sees value in the local sovereign bond market in Malaysia, Korea, and Thailand where they will consider investing.
For Malaysia and Korea, it is the high local yields and the carry one can get to invest in those markets. For Thailand, it’s the high implied carry in the investment that makes it attractive.
But Broustra stressed that they will be “extremely selective” by name and duration, rather than simply buying the full market basket.
ASIAN INVESTMENT GRADE
Asian corporate credit is also in good shape compared with the rest of emerging market credit as it relies less on US debt. This is also because local currencies in Asia have been more resilient against the US dollar, Broustra noted.
“The fundamentals are OK as long as you get out of some sectors like Chinese property for instance,” he said. “But still, what we've observed in the Asian investment grade credit market is that it's proven more resilient than the rest of the other investment grade credit market.”
In the fourth quarter, Asian bonds will be slightly overweight in AXA IM’s fixed income portfolio driven by shorter duration bonds.
But looking beyond 2022 towards the full year of 2023, as inflation peaks and the world enters a possible recession, Broustra thinks it is still a positive environment for fixed income investment. However, investors are likely to turn their focus to longer duration strategies to benefit from the carry of the long duration bonds under a recessionary environment.
Nevertheless, he said it’s important to remain cautious because there are still a lot of uncertainties with regard to geopolitical concerns, or any global recession as well as a peak in the default rate.
“We expect this default rate to be manageable. But even if it’s manageable, it is going to trigger a higher volatility environment,” he said.
Broustra said they project that inflation will probably peak by the second quarter of next year, followed by technical recessions in the US and Europe with some consecutive quarters with negative GDP growth.
Under such an environment, it will be about focusing on longer-duration products to benefit from the end of the rising rate environment and the repricing of the credit spread in the market.
“That's going to be a major move we expect in the course of 2023,” he said.
DIVERSIFICATION
Morningstar Manager Research team also echoed AXA IM with findings that showed most fixed income and multi-asset managers have recently taken steps to increase their portfolio duration despite expectations of further rate hikes since they believe most future rate hikes have been priced into the market.
Increasing duration is seen as a defensive move in anticipation of market volatility and a potential slowdown in growth, moves that have often been paired with a reduction in corporate credit exposure or equity exposure in the context of multi-asset funds, the Morningstar Manager Research released on Nov 4 noted.
Meanwhile, several managers have been diversifying outside of core global markets in Asia Pacific as well. Global bond managers – such as Brandywine Global Investment Management - shifted the overweights to the Japanese yen, as they believe the yen will find its bottom thanks to incipient inflation pressure and Ministry of Finance or Bank of Japan intervention.
Others, meanwhile, have been in favour of select emerging markets exposure, for example in Malaysia, Mexico, and South Korea, including Colchester Global Investors.
BlackRock’s Asian fixed-income team noted that inflation expectations are declining in most Asian countries, but expects default rates in Asia to remain elevated over the next year compared with historical averages as China property names continue to come under severe pressure.
However, they believe China’s efforts to boost its technology independence from the US should foster long-term stability.