Market Views: Will Asia’s bond appeal revive in 2019?
Illiquid, crowded out by bank lending and bereft of reliable credit ratings, the Asian bond market was seen as a relatively underdeveloped asset class going into 2018.
Unfortunately, the past 12 months didn't do much to reverse these concerns. Rather than witness its continued evolution, market participants were left disappointed by further US interest rate rises and the growing China-US trade conflict, which combined to drag on bond performance and issuance.
Heading into 2019, AsianInvestor asked four fixed-income experts for their views of the market, including the most appealing opportunities and the risks that investors should be most mindful of.
The following extracts have been edited for brevity and clarity.
Low Guan Yi, fixed income chief investment officer
Eastspring Investments
Both Asian local- and hard-currency bond markets have been subject to selling pressure in 2018 as the tightening of global liquidity conditions, broad US dollar strength and rising trade tensions weighed on sentiment. In 2019, we expect the investment environment to be more stable; as global expansion continues but at a slower pace, investor concerns over monetary policy tightening will be less of a headwind in 2019. The reduced focus on global themes will then allow individual country themes to surface, allowing our portfolios to focus on strategic allocations based on fundamental and valuation opportunities.
In this environment, we see opportunities in select segments and individual credit names which have been oversold. In the local bond markets, we are positive on Indonesian, Indian and Philippines local currency bonds. In the Asian hard-currency credit market, we [believe] the high-yield bond sector presents opportunities following its underperformance versus the investment grade and developed markets ... With current credit spreads above 600 basis points, the sector is pricing in excessive default risk.
That said, we are starting to observe that the refinancing cycle for Asian high-yield corporates is getting shorter; many companies are only able to refinance into three years or shorter tenors, reflecting the tighter funding conditions. We see some Chinese property companies scaling back their land bank purchases as funding becomes more difficult. For this reason, we must be selective and invest in companies that can refinance in the next two to three years.
Manu George, investment director for Asian fixed income
Schroders
We are bullish about opportunities in Asian bonds for 2019. We expect Asian currencies to dominate returns in 2019 within the Asian local-currency bond universe.
Asian currencies are trading at cheap levels as a result of worries that arose in 2018 around the Sino-US trade war, weaker Asian growth, higher commodity prices and poor market sentiment towards emerging markets ... Furthermore, yields in parts of the Asian local-currency bond market have also risen dramatically with Indian, Indonesian and Philippines government bond yields in excess of 6.8%.
With the US dollar currency looking expensive on a real effective exchange rate basis as well as expectations that the US Federal Reserve is unlikely to be aggressive with monetary policy normalisation, Asian currencies are likely to strengthen.
For Asian US dollar-denominated bonds, the market has cheapened considerably with investment grade and non-investment grade bond yields at eight-year highs, offering over 5% and 9.1% [per year], respectively. We believe that the rate of yield increases is likely to slow down in the next few months, offering very attractive opportunities to enhance dollar-denominated/income-orientated fixed-income portfolios.
We believe that it pays to be selective and [that a] disciplined credit research will reward investors. Returns are likely to be driven by a robust focus on bottom-up issuer selection with market beta likely to remain volatile in light of ongoing Sino-US trade tensions and a potential easing of select US growth drivers.
Jim Veneau, head of fixed income for Asia
Axa Investment Managers
Wider spreads and higher yields at the end of 2018 should set markets up for better returns early next year, particularly in emerging markets, where a wide range of risks have already been priced in by investors. The epicentre of the trade war, Asia, is one such region.
Even accounting for the ebb and flow of trade war concerns, compensation for Asian fixed-income exposure in sold-off high yield sectors and local currency markets appears attractive in terms of both deviations from longer-term historical averages as well as on a relative-value comparison with other regions. Both the Indian rupee and Indonesian rupiah [currencies] hit record lows versus the dollar and [at the end of November] Asian high-yield bonds traded almost 300 basis points higher than US high-yield bonds.
Risk exposure in this market comes with the caveat that, despite an abundance of attractive valuations, higher levels of volatility have returned to the region and are likely here to stay, especially while trade war discussions go back and forth. Vigilance must also remain for idiosyncratic risks as corporate governance concerns continue to lurk and almost always spook investors whenever they emerge in the headlines.
This should then be a market that rewards local knowledge and experience as the alert and well-researched investor can more confidently identify bargains and add value to a range of both regional and global strategies.
Omar Slim, senior vice president and portfolio manager for fixed income
PineBridge Investments
We think there will be three themes dominating the Asian fixed-income markets in 2019. The first is the continuous but more gradual, monetary policy normalisation, which impacts financial conditions directly. The second is that the credit cycle has peaked and, as such, one needs to be highly selective in credit selection. The third is related to China, its ongoing deleveraging, its economic and political relationships with the United States and its economic policy fine-tuning.
Those themes mean you have to be surgical in your credit selection and very calibrated in risk-taking, cognisant that we’re entering a new post-quantitative easing phase that does not have the same kind of parental support from the central banks. It also means that one needs not to get carried away by being overly negative, as the fundamentals generally for Asian fixed income, particularly in the investment-grade segment, remain good and opportunities abound.
Within high yield, we continue to see opportunities and we think the valuation is interesting for some names but we’re generally cautious and even more selective in that segment.