Retail investors may replace pension funds in Asian fixed income

When Veronique Lafon-Vinais, adjunct associate professor at the Hong Kong University of Science and Technology, asked her panel of three at the AsianInvestor and FinanceAsia debt forum last week to look into their crystal balls, they said they saw a rosy future for fixed-income securities.

They also concluded that the current growth in local currency markets is the result of a strong domestic bid and, unless key markets are opened up to international investors, that growth could be capped.

"A lot of markets are very domestic and [aren't attracting] an offshore investor base," said Peter Sengelmann, fixed-income specialist with Western Asset Management.

For example, Indonesia currently has a 20% participation rate for international investors in its fixed-income market, whereas India, which is the second largest market in Asia, has a participation rate of 1.7%. "Until these markets open up there's going to be a ceiling" on their future potential, added Sengelmann.

Viktor Hjört, head of fixed-income research and credit strategy at Morgan Stanley, said even if we estimate the amount of debt that could be raised in Asia to be $500 billion, this would make it only one-sixth the size of the current corporate US bond market. "When you look at the amount of debt that could be raised, there is huge potential for growth," said Hjört.

In the large-capital, non-financial corporate market in Asia there is an estimated $3 trillion worth of money to be raised. This assumes a growth rate in Asia of 7% plus 3% inflation on top of that. Then, assuming 50% of the money raised comes from the equity markets and the remaining 50% is sold on the debt markets, there is going to be a lot of debt irrespective of what corporations do with their balance sheets.

"There's plenty of scope for the loan market relative to the local currency markets as well as the dollar market to grow rapidly alongside each other," said Hjört.

Along with this expected growth in issuance will come an increased appetite for fixed-income assets from investors, said the panellists.

The savings culture that exists in emerging markets has meant that Asian investors have traditionally taken their savings and invested in developed economies, which have been viewed as a safe bet. This is "why there's been a flight of volumes in Treasuries", explained Sengelmann. The knock-on effect has helped keep interest rates in markets like the US lower for longer, certainly longer than what had been expected.

But now the tide is turning and investment flows are entering emerging markets like Asia. "A savings pick up in developed economies has resulted in investors looking for a better place to invest their money," said Sengelmann, "and emerging markets have a comparative advantage [to developed economies] of higher return assets."

The correlation between Asian equities and local currency bonds has been 0.5 over the past six years, whereas the correlation between Asian local currency bonds and US and global bonds has been 0.2 for the same period. On a stand-alone basis it would appear that Asian local currency bonds hold up very well.

Returns in the Asian markets (in US dollars) are 7% and the risk of that is also 7%. "This is a pretty decent trade-off," commented Sengelmann.

For now, the dominant buyers of Asian fixed-income securities are local pension funds. But, Sarvjeev Sidhu, global head of emerging markets for AEGON USA Investment Management, said that when equity volatility begins to diminish, these pension funds will move back to the equity markets and equities will, once again, outperform bonds.

With the likely departure of pension funds from the bond markets, it may be that retail investors take up the slack.

"Retail currently has an equity [bias]," said Sengelmann, "But if retail investors were to take up the mantle and start buying fixed income, it could be enough to move the needle." Whether this will happen remains to be seen.