Eurozone woes turn Asian debt into mainstream asset class
Views among Asian asset managers on what constitutes a safe haven these days span the international spectrum, from US Treasuries to Asian credits – that is if such a thing exists at all.
Pimco, for instance, regards US Treasuries as “the cleanest of the dirty shirts”, according to its Asia CEO and director Brian Baker.
He notes that while large developed market sovereigns are suffering from rising deficits and slowing growth, emerging markets have proved a volatile asset class and their capital markets are not large or accessible enough for risk-averse investors to seek safety.
Similarly, Henry Hamrock of Western Asset Management views US Treasuries as low risk and highly liquid, “thus offering a form of safe haven status for investors who do not want to risk a sudden loss of liquidity or capital”.
Hamrock does, however, say he is not sure there is such a thing as a safe haven any more, and concedes that Western Asset finds it hard to take large positions in bunds as it expects yields to remain anchored near current levels for quite some time.
Matthew Richards, global investment solutions strategist for UBS Global Asset Management, agrees there are no risk-free assets any more.
“But while the default risk of government bonds is not negligible, debt issued by central banks that issue the currency in which the debt is denominated can, in some cases, still be seen as a relatively safe haven,” he counters (depending on risk profile).
In terms of eurozone sovereign debt, Hamrock says Western Asset is mostly exposed to Europe’s core and prefers to maintain reduced exposure to the periphery.
“However, as a long-run value investor we do see opportunities in certain areas of the periphery now that spreads have widened so dramatically in the past few months,” he adds.
“Certain areas along the Italian yield curve, for example, are beginning to look more attractive and we will continue to look for tactical investment opportunities as peripheral spreads fluctuate.”
Western Asset believes some form of resolution to the eurozone sovereign debt crisis will be reached. “This will probably involve greater support for the European banking system and providing a ring-fence for the stronger, systematically important member states,” notes Hamrock.
The firm continues to hold a constructive medium-term view on Asian debt, while acknowledging that the beneficial impact on price valuations could be clouded by external developments, at least temporarily.
“Looking beyond the near-term headwinds, we expect the emerging market/developed market divergence to reinforce the ongoing transformation of Asian debt from a peripheral allocation to a mainstream asset class.”
Asked her view on safe havens, Cecilia Chan, CIO of Asia-Pacific fixed income at HSBC Global Asset Management, points to Asian government bonds, noting that debt levels are falling as a percentage of the size of the economies and credit fundamentals are actually improving.
Further, with conservative balance sheets she says Asian credits are well positioned to weather economic storms and will benefit from any global economic upturn as valuation levels are good.
“Asian local government bonds in particular would benefit from looser monetary policies in domestic economies as inflationary pressure is subsiding amid slower global growth economies,” she adds.
Both Hamrock and Baker dismiss the threat of near-term inflation, although as Richards notes the unstable macroeconomic environment means that could change.
Richards takes the view that the most likely scenario is that the euro is saved, with the long-term survival of the single-currency eurozone bloc looking far less uncertain if it can survive the next two years.
But he adds: “Bearish scenarios are negative for Asian debt, since increased risk perception would probably lead to a withdrawal of international investors from Asian debt markets.”
Chan of HSBC agrees that Asian USD credits would suffer from credit spread widening in an extreme risk-averse scenario, although part of the yield rise would be compensated by the expected decline in US Treasury yields.
“Asian debt (USD or local currency) would clearly not be immune from any major global market dislocation,” she adds. “However, we believe very strongly in the medium- to long-term attractiveness of both of these asset classes in risk-weighted terms.”
While she does not believe the eurozone will break up, she thinks we could be many months away from a definite resolution.
Pimco’s base-case expectation is that several countries will leave the eurozone, either permanently or on a sabbatical in which they would regain their local currency and control of their monetary policy and make the necessary adjustments to make their economies more competitive and to rehabilitate their fiscal balance sheet.
“However, a disorderly default by one of more of the eurozone countries or a messy breakup of the eurozone is not a negligible risk given the extended policy deliberations and indecisions, which increases the likelihood of a left-tail outcome,” says Baker, who thinks the tail-risk is significant enough to factor such an outcome into Pimco’s investment decisions.
Asked whether he views sovereign credit default swaps (CDS) as useful risk-management tools, Richards says UBS Global Asset Management has very little direct exposure to these markets but is monitoring developments.
“We participate more in CDS markets for corporate debt and have greater confidence in this section of the overall CDS market,” he adds.
While Chan says such instruments can be useful in some circumstances, Baker suggests the sovereign CDS market is still in the process of being defined.
“Clearly one has to wonder whether buying sovereign CDS really protects you against default if a 21% or perhaps 50% haircut on Greek debt does not constitute a default event, even under ISDA [International Swaps and Derivatives Association].”