Market Views: Have Asian bonds become a good bet?
Two years ago, Asian bonds were seen by some asset owners as being unattractive investments due to their illiquidity, among other deficiencies.
The local capital markets in the region are still relatively underdeveloped and a lack of liquidity is one result. That makes even finding local currency and US dollar bonds from the region a difficult task, said Liew Tzu Mi, chief investment officer for fixed income at Singapore sovereign wealth fund GIC, in 2018.
But two years on, the tide may be turning. Issuance levels have improved choice and investors are keen to find relative yield. Asian bonds can particularly fit the bill, due to the fact they often trade a little wider than equivalents in the US or Europe, and yet their default risks are generally seen to be lower.
The Asian bond market is less vulnerable than the US because more corporates in this region will likely receive more sovereign support, in contrast to those in the US, so the region's default rates will be contained, said Jethro Goodchild, Hong Kong chief investment officer at insurer FWD. He has noted that is particularly the case with high yield bonds, where Asian issuers tend to be more state-linked and not hailing from badly impacted businesses like hotels or airlines.
We asked five fixed income experts to elicit the top challenges and appeals of Asian bond investing, and whether this really is a good time to invest, given the broader challenges facing the world.
The following contributions have been edited for clarity and brevity.
Angus Hui, head of Asian and emerging markets for credit
Schroders
Covid-19 has had a significant negative impact to credit fundamentals globally and the de-globalisation trend has also created uncertainties. High market volatility is likely to stay.
We expect leverage to increase across most Asian corporate issues to counteract the impact from Covid-19. In China, we also believe credit clean-up remains a priority for policymakers such that they would allow more defaults to occur in a controlled manner as problem credits emerge, but would provide stronger support if required to avoid systemic concerns.
However, compared to previous economic downturns such as in 2008 and 2009 and 1997 to 1998, Asian credits have strong fundamental backdrops and refinancing concerns are much lower this time. Most banking sectors in the region have sufficient capitalisation and liquidity buffers to withstand a pick-up of problem loans.
In an extremely low interest rate environment, income becomes increasingly difficult to source and Asian credits offer attractive yield and risk/reward profile for institutional investors. Active management in regional credit has become more important than ever against the backdrop of deteriorating of credit fundamentals, and as additional liquidity floods the market as investors search for yield. This might bid up risk asset prices, both good and bad.
Fiona Cheung, head of credit for Asia
Manulife Investment Management
The wave of fallen angels and defaults has started globally, but these risks will be more acute in the developed markets and should be more subdued in Asia.
Overall, we think that Asian credits are in a relatively better position to withstand the economic shocks arising from Covid-19 compared to global peers. Firstly, the credit quality of regional debt is generally high. Secondly, the Asian local currency bond markets are well established.
Asian investment-grade companies have the flexibility to issue local currency bonds in their home market and are not overly reliant on US dollar bonds alone. Moreover, about 40% of the issuers in JP Morgan Asia Credit Index are governments or government-related entities. Plus Asian bonds have limited exposure to industries badly hit by Covid-19; gaming, leisure, and retail accounted less than 3% of the index.
We think that credit selection is of paramount importance. It’s important to assess and analyse government support on a case-by-case basis, by looking at whether an issuer plays a strategic or policy role; whether it operates in a highly strategic industry; and in the event of a company’s defaults, whether it will have a systemic or contingent effect on the financial system.
Sheldon Chan, co-portfolio manager for Asia credit bond strategy
T. Rowe Price
Credit selection will be the most important driver of returns going forward in US dollar-denominated Asia credit amid a divergence in how countries and sectors are navigating through the coronavirus pandemic.
As we enter a period of elevated default risk, it is imperative to identify companies which have secure liquidity profiles and are best equipped to withstand further spikes in volatility. The market will also be more discriminating after a recent rally has seen spreads narrow from March’s sharply higher levels.
On the other hand, Asia credit has reaffirmed that it can deliver strong downside protection while still providing income opportunities. Spread widening during the recent sell-off was more contained versus other emerging market regions and corresponding US high yield and investment grade markets.
Importantly, Asia Pacific is also relatively less exposed to the pandemic, and it more broadly has lower representations in demand-hit sectors like commodities and travel.
Investors should adopt a bottom-up, fundamental approach to identify the winners and also maintain a diversified exposure that includes investment grade credits, given potential tail risks like the path of the pandemic and renewed US-China tensions.
Eric Liu, head of fixed income
Harvest Global Investments
The dynamics in Asia are very different from the ones in the US and Europe. In Asia, central bank support to the bond markets is less direct. They rely on domestic liquidity easing, which in turn incentivises investors to look for additional yield in the same credits denominated in US dollars. Hence liquidity in Asia will be more fragile than comparable markets.
However, the fundamentals of Asia are more resilient than most emerging markets. The region is less correlated to oil, while tight valuations in Asian credits compared to other emerging markets reflect the region’s stronger government finances, economic outlook and handling and containment of the Covid-19 situation.
It's a good time to invest in Asian bonds now, especially given the high correlation between US investment grade and Asian credits. US investment grade bonds have been trading tighter on the back of the Federal Reserve’s facilities and support.
Spread-wise, from a historical perspective, further tightening and opportunities can still be expected in Asia. But it's important to be prudent and invest in credits that are fundamentally strong and can withstand volatility. Liquidity will likely come and go, so riding through volatility will be key.
Eric Wong, portfolio manager
Fidelity International
The global collectively-coordinated central bank and government policy action, to various degrees, provides a supportive backdrop for Asian bond markets. We expect Asia, in particular China, to be the first to emerge from the outbreak. China should recover relatively faster than the rest of the world, given its willingness and ability to ramp up stimulus in monetary and fiscal terms.
Amid the supportive market backdrop, we think valuations look very attractive in Asia investment grade bonds. Despite a strong rebound in the second quarter, these bonds' spreads are still at around 60% to 70% wide from pre-crisis level. We prefer countries including China, Indonesia and Thailand on the back of better fundamentals and attractive valuations.
Credit selection is the key to identifying high quality companies and to avoid fallen angel risks. With all the market uncertainties ahead, from a Covid-19 second wave to the resumption of US-China trade tensions, high quality credits like Asia IG bonds with attractive risk premia should be well positioned for investors to navigate the uncertainties.