Crisis presents opportunities in Asian fixed income
The FTIF Templeton Asian Bond Fund remains highly selective about the countries and credits it invests in and is currently overweight in Indonesia, Korea and Malaysia.
Michael Hasenstab is a co-director and portfolio manager for the international bond department of the Franklin Templeton fixed-income group. Based in California, he co-directs all investment strategies within the international fixed-income group and co-manages the portfolio management team. He specialises in global macroeconomic analysis with a focus on currency, interest rate and sovereign credit analysis of developed and emerging market countries. He has worked and travelled extensively in Asia, published research on ChinaÆs financial market and consulted global companies on Asia-Pacific investments and strategy. He shares with AsianInvestor his views about AsiaÆs fixed-income market.
We are experiencing a prolonged credit crisis in the US and a persistent volatility in financial markets in the US and elsewhere in the world. What does this all mean for Asian fixed-income markets?
Hasenstab: There are two channels through which the financial turmoil in the US is likely to impact the rest of the world. First, the deleveraging process that is already underway is not confined to the US. This is having a particularly acute impact on developed economies where businesses and consumers are dependent upon credit. The weakness in housing markets in many parts of the world is characteristic of this trend, which despite the best efforts of policy makers, is likely to be a prolonged one. Conversely, Asian consumers, corporations and governments generally use relatively less leverage, in part as a legacy of the Asian financial crisis of the late 1990s, which should mean their economies are less vulnerable than other parts of the world. The second channel by which the US slowdown impacts the rest of the world will be through trade and capital flows. Particularly vulnerable to this real economy transmission are countries like Mexico that are dependent on the US as a destination for the majority of its exports as well as a source of remittances and tourism.
We continue to believe that non-Japan Asia will continue to weather the global downturn successfully. Even if growth is below trend, GDP is still expected to expand in excess of 6% this year by the IMF. Growth may further benefit from national governments bolstering domestic demand through fiscal spending as several have significant resources as a result of prudent fiscal policies. This differential in growth between Asia and other parts of the world should continue to attract capital to the region, benefiting regional currencies and improving credits.
What has been the impact of the credit crisis in the US on Asian currencies?
We have been seeing currencies fall against the US dollar fairly indiscriminately, but we are beginning to see some differentiation in the performance of individual currencies. We expect this differentiation to become more marked in the next couple of years as a result of global re-balancing. This may result in the currencies of Asian countries with sound fundamentals appreciating against the US dollar, but making even more significant progress against the euro. Consequently, we have taken advantage of the recent broad-based weakness to increase our exposure to some Asian currencies.
In brief, our medium-term, fundamentals-driven approach means we continue to favour Asian currencies and view the euro as overvalued. We are also of the belief that the dollar may benefit in the medium term from the USÆ decision to deal with its financial sector problems fairly aggressively, in marked contrast with the Europeans, where similar problems look set to be longer drawn out.
What has been the impact of the credit crisis in the US on Asian interest rates?
We see this global backdrop as a positive environment for some fixed-income securities given the tighter credit conditions and dislocation in interbank lending has now left overall monetary conditions restrictive. As a result, central banks globally have additional room reduce interest rates as the global economy slows. We expect that evidence that growth is below trend will allow an increasing number of countries to ease monetary policy, especially as the threat posed by rising fuel and food prices fades. Even should inflation still be above target, we believe more central banks will follow similar policies as New Zealand and Australia by cutting rates as the balance of risks shifts toward addressing weak growth. All in all, we are looking to add interest rate exposure in countries that have begun to be affected by the global downturn but in which markets have yet to price in a monetary policy reaction.
Countries where inflation is mostly the result of a short-term supply shock, conditions are in place for weak growth, and central banks are credible, market volatility could present especially attractive buying opportunities. Indeed, we have used recent weakness to reinforce our duration exposure in several such countries including Korea.
What is your overall Asian fixed-income investment strategy over the next 12 months?
The current market dislocation affords tremendous opportunities to invest in interest rate, currency and credit markets in the months ahead. In particular, we maintain a positive outlook on prospects for top-tier financial institutions, which we believe will emerge strongly from the current crisis, having taken sizable write-downs up front. The widening of credit spreads means we are being paid for holding such investments. We have been focusing on top-tier financials because we think that stresses in the capital markets are such that lower tier institutions could well face additional difficulties before the year is out. Credit will continue to be an important source of opportunities for us going forward, especially given the forced selling we have seen this month.
Inflation has been a key issue for the Asian economies. We believe market volatility could present attractive buying opportunities in some countries as certain central banks should be well positioned to reduce interest rates as the supply shock of rising food and energy prices fades. Our most significant duration positions presently are in Indonesia and South Korea. We are also looking to identify economies where capacity is constrained, inflation is domestically driven and supply shocks threaten to de-anchor inflation expectations. In these situations, where rate hikes are likely to be larger and more extended, higher short-end interest rates should be supportive for many currencies in Asia.
Do you have a preference for either corporate or government bonds?
The FTIF Templeton Asian Bond Fund is actively managed independent of its benchmark in order to maximise total returns. This is accomplished through fundamentals-driven analysis of opportunities throughout Asia irrespective of sector. A top-down, trends perspective is complemented by a bottom-up focus on the securities that offer the best value in order to build the portfolio. As a result we do not have a specific preference for corporate or government bonds. Rather, we seek fixed-income securities with superior valuations where and when they are available.
Do you have a bias towards investment-grade bonds, given the uncertainty in global financial markets?
Given the difficult global environment, we believe it will pay to remain highly selective about the countries and credits in which we invest. We remain focused on our medium-term fundamentals-driven approach to take advantage of opportunities in Asian countries with sound fundamentals (good fiscal policies, large currency reserves, current account surpluses, etc) that could recover relatively quickly from recent panicked selling.
Do you have a stronger view towards a particular fixed-income market in Asia?
FTIF Templeton Asian Bond Fund currently has overweight positions in Indonesia, Korea and Malaysia.
Indonesia has come a long way from the Asian financial crisis of a decade ago. The steep decline of the rupiah, skyrocketing food prices, and mass riots of that period eventually brought down President SuhartoÆs regime. But more recently, Indonesia has enjoyed rising foreign investment due to high growth prospects and rich natural resources. IndonesiaÆs inflation trend has benefited from improved macroeconomic management. High local interest rates, intended to counter supply-driven inflation, make duration exposure attractive and should also support the rupiah going forward.
In Korea, we believe the combination of a credible central bank, supply-driven inflation, and moderating growth caused is to add duration exposure. Recently, this view has been justified as the Bank of Korea cut interest rates in what we believe could be the beginning of an easing cycle. While in the current environment, building such positions that go against market momentum can hurt short-term performance, we believe that adding exposures with such attractive valuations relative to their underlying fundamentals will pay off over the medium term.
We remain bullish on Malaysia as we expect relatively strong growth to be held up by resilient domestic demand. While the political situation remains complicated, the potential for Malaysia to execute counter-cyclical fiscal spending may also benefit growth. The external sector remains a positive for the economy as we expect the current account surplus to be maintained by high soft-commodity prices, especially for palm oil. Steady demand from China has underpinned these high prices, which should help offset weakness in demand for electronic exports from the slowing developed economies. Inflationary pressures and high prices for dollar denominated commodities increase the incentives for currency appreciation throughout the region.
One of the most common criticisms of global fund managers is the lack of depth in secondary fixed-income markets in Asia. How are you able to find value in the market under such conditions?
While the recent volatility has reduced the liquidity and transparency of markets around the world, it has also produced some very attractive values as risk aversion led to broad based selling. We are confident in our fundamentals driven investment approach informed by the depth and capacity of our global research and investment platform. At Franklin Templeton we apply an active management strategy unconstrained by the benchmark, which allows us to pursue absolute returns over a one to three year horizon by investing in all manner of fixed-income instruments. Quantitative and qualitative analysis is conducted to complement top-down relative value with bottom-up sector and security analysis. The depth and breadth of our teamsÆ expertise provide the geographic and sector specialisation to capitalise on opportunities and ensure broad diversification of investment ideas throughout the Asian fixed-income universe.
What have been the main challenges you have faced in managing an Asian fixed-income portfolio over the past 12 months?
The challenges facing Asian fixed income include investorsÆ fears, continued volatility in the credit markets, a re-pricing of risk and the subsequent flight to quality. However, we believe that many countries in Asia offer attractive valuations and buying opportunities. We will continue to focus our duration exposure on countries where inflation is mostly supply driven, conditions are in place for weak growth, central banks are credible and the market has fully priced in potential interest-rate tightening. This combination should allow central banks to cut interest rates as the supply shock fades and risks to growth increase. In terms of currencies, we are focused on countries with relatively strong growth, solid external balances, and low financing needs.
The November edition of AsianInvestor magazine contains a feature on the Asian fixed-income market.
We are experiencing a prolonged credit crisis in the US and a persistent volatility in financial markets in the US and elsewhere in the world. What does this all mean for Asian fixed-income markets?
Hasenstab: There are two channels through which the financial turmoil in the US is likely to impact the rest of the world. First, the deleveraging process that is already underway is not confined to the US. This is having a particularly acute impact on developed economies where businesses and consumers are dependent upon credit. The weakness in housing markets in many parts of the world is characteristic of this trend, which despite the best efforts of policy makers, is likely to be a prolonged one. Conversely, Asian consumers, corporations and governments generally use relatively less leverage, in part as a legacy of the Asian financial crisis of the late 1990s, which should mean their economies are less vulnerable than other parts of the world. The second channel by which the US slowdown impacts the rest of the world will be through trade and capital flows. Particularly vulnerable to this real economy transmission are countries like Mexico that are dependent on the US as a destination for the majority of its exports as well as a source of remittances and tourism.
We continue to believe that non-Japan Asia will continue to weather the global downturn successfully. Even if growth is below trend, GDP is still expected to expand in excess of 6% this year by the IMF. Growth may further benefit from national governments bolstering domestic demand through fiscal spending as several have significant resources as a result of prudent fiscal policies. This differential in growth between Asia and other parts of the world should continue to attract capital to the region, benefiting regional currencies and improving credits.
What has been the impact of the credit crisis in the US on Asian currencies?
We have been seeing currencies fall against the US dollar fairly indiscriminately, but we are beginning to see some differentiation in the performance of individual currencies. We expect this differentiation to become more marked in the next couple of years as a result of global re-balancing. This may result in the currencies of Asian countries with sound fundamentals appreciating against the US dollar, but making even more significant progress against the euro. Consequently, we have taken advantage of the recent broad-based weakness to increase our exposure to some Asian currencies.
In brief, our medium-term, fundamentals-driven approach means we continue to favour Asian currencies and view the euro as overvalued. We are also of the belief that the dollar may benefit in the medium term from the USÆ decision to deal with its financial sector problems fairly aggressively, in marked contrast with the Europeans, where similar problems look set to be longer drawn out.
What has been the impact of the credit crisis in the US on Asian interest rates?
We see this global backdrop as a positive environment for some fixed-income securities given the tighter credit conditions and dislocation in interbank lending has now left overall monetary conditions restrictive. As a result, central banks globally have additional room reduce interest rates as the global economy slows. We expect that evidence that growth is below trend will allow an increasing number of countries to ease monetary policy, especially as the threat posed by rising fuel and food prices fades. Even should inflation still be above target, we believe more central banks will follow similar policies as New Zealand and Australia by cutting rates as the balance of risks shifts toward addressing weak growth. All in all, we are looking to add interest rate exposure in countries that have begun to be affected by the global downturn but in which markets have yet to price in a monetary policy reaction.
Countries where inflation is mostly the result of a short-term supply shock, conditions are in place for weak growth, and central banks are credible, market volatility could present especially attractive buying opportunities. Indeed, we have used recent weakness to reinforce our duration exposure in several such countries including Korea.
What is your overall Asian fixed-income investment strategy over the next 12 months?
The current market dislocation affords tremendous opportunities to invest in interest rate, currency and credit markets in the months ahead. In particular, we maintain a positive outlook on prospects for top-tier financial institutions, which we believe will emerge strongly from the current crisis, having taken sizable write-downs up front. The widening of credit spreads means we are being paid for holding such investments. We have been focusing on top-tier financials because we think that stresses in the capital markets are such that lower tier institutions could well face additional difficulties before the year is out. Credit will continue to be an important source of opportunities for us going forward, especially given the forced selling we have seen this month.
Inflation has been a key issue for the Asian economies. We believe market volatility could present attractive buying opportunities in some countries as certain central banks should be well positioned to reduce interest rates as the supply shock of rising food and energy prices fades. Our most significant duration positions presently are in Indonesia and South Korea. We are also looking to identify economies where capacity is constrained, inflation is domestically driven and supply shocks threaten to de-anchor inflation expectations. In these situations, where rate hikes are likely to be larger and more extended, higher short-end interest rates should be supportive for many currencies in Asia.
Do you have a preference for either corporate or government bonds?
The FTIF Templeton Asian Bond Fund is actively managed independent of its benchmark in order to maximise total returns. This is accomplished through fundamentals-driven analysis of opportunities throughout Asia irrespective of sector. A top-down, trends perspective is complemented by a bottom-up focus on the securities that offer the best value in order to build the portfolio. As a result we do not have a specific preference for corporate or government bonds. Rather, we seek fixed-income securities with superior valuations where and when they are available.
Do you have a bias towards investment-grade bonds, given the uncertainty in global financial markets?
Given the difficult global environment, we believe it will pay to remain highly selective about the countries and credits in which we invest. We remain focused on our medium-term fundamentals-driven approach to take advantage of opportunities in Asian countries with sound fundamentals (good fiscal policies, large currency reserves, current account surpluses, etc) that could recover relatively quickly from recent panicked selling.
Do you have a stronger view towards a particular fixed-income market in Asia?
FTIF Templeton Asian Bond Fund currently has overweight positions in Indonesia, Korea and Malaysia.
Indonesia has come a long way from the Asian financial crisis of a decade ago. The steep decline of the rupiah, skyrocketing food prices, and mass riots of that period eventually brought down President SuhartoÆs regime. But more recently, Indonesia has enjoyed rising foreign investment due to high growth prospects and rich natural resources. IndonesiaÆs inflation trend has benefited from improved macroeconomic management. High local interest rates, intended to counter supply-driven inflation, make duration exposure attractive and should also support the rupiah going forward.
In Korea, we believe the combination of a credible central bank, supply-driven inflation, and moderating growth caused is to add duration exposure. Recently, this view has been justified as the Bank of Korea cut interest rates in what we believe could be the beginning of an easing cycle. While in the current environment, building such positions that go against market momentum can hurt short-term performance, we believe that adding exposures with such attractive valuations relative to their underlying fundamentals will pay off over the medium term.
We remain bullish on Malaysia as we expect relatively strong growth to be held up by resilient domestic demand. While the political situation remains complicated, the potential for Malaysia to execute counter-cyclical fiscal spending may also benefit growth. The external sector remains a positive for the economy as we expect the current account surplus to be maintained by high soft-commodity prices, especially for palm oil. Steady demand from China has underpinned these high prices, which should help offset weakness in demand for electronic exports from the slowing developed economies. Inflationary pressures and high prices for dollar denominated commodities increase the incentives for currency appreciation throughout the region.
One of the most common criticisms of global fund managers is the lack of depth in secondary fixed-income markets in Asia. How are you able to find value in the market under such conditions?
While the recent volatility has reduced the liquidity and transparency of markets around the world, it has also produced some very attractive values as risk aversion led to broad based selling. We are confident in our fundamentals driven investment approach informed by the depth and capacity of our global research and investment platform. At Franklin Templeton we apply an active management strategy unconstrained by the benchmark, which allows us to pursue absolute returns over a one to three year horizon by investing in all manner of fixed-income instruments. Quantitative and qualitative analysis is conducted to complement top-down relative value with bottom-up sector and security analysis. The depth and breadth of our teamsÆ expertise provide the geographic and sector specialisation to capitalise on opportunities and ensure broad diversification of investment ideas throughout the Asian fixed-income universe.
What have been the main challenges you have faced in managing an Asian fixed-income portfolio over the past 12 months?
The challenges facing Asian fixed income include investorsÆ fears, continued volatility in the credit markets, a re-pricing of risk and the subsequent flight to quality. However, we believe that many countries in Asia offer attractive valuations and buying opportunities. We will continue to focus our duration exposure on countries where inflation is mostly supply driven, conditions are in place for weak growth, central banks are credible and the market has fully priced in potential interest-rate tightening. This combination should allow central banks to cut interest rates as the supply shock fades and risks to growth increase. In terms of currencies, we are focused on countries with relatively strong growth, solid external balances, and low financing needs.
The November edition of AsianInvestor magazine contains a feature on the Asian fixed-income market.
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