Unlocking high-quality Asian bond opportunities in uncertain times
Two themes figured prominently in the Asian bond market this year: the US-China trade dispute and monetary easing.
On one hand, rate cuts by the US Federal Reserve and several Asian central banks provided a positive backdrop for Asian bonds. With developed market bonds offering negative to negligible yields, higher-yielding Asian bonds became harder to ignore. Fundamentals remain sound as Asian corporates continue to see an improving trend on their net leverage, which is driven by moderation in capital expenditures and mergers and acquisitions amid slower growth.
co-head of emerging markets fixed income and head of Asia ex-Japan fixed income, PineBridge Investments
On the other hand, trade uncertainty remains and that could lead to choppy Asian bond and currency markets in the near term. But Arthur Lau, head of Asia ex Japan fixed income for PineBridge Investments, which manages more than $14 billion in Asia ex Japan fixed income strategies across US dollar and local currency investment grade and high-yield credit1, believes this should not take the shine off Asian bonds.
“When market volatility exists, the Asian bond market becomes more attractive to long-term institutional investors,” he says. “Contrary to perception, the Asian bond market is not a high-yield market with high beta and volatility.” Investment-grade bonds account for approximately 80% of the market2.
STABLE FUNDAMENTALS
Over the past five years, Asian bonds’ Sharpe ratio (i.e., the volatility-adjusted return ratio) has held up very well at 1.59 compared with those of other major asset classes globally (US investment-grade credit: 0.99, emerging markets US dollar: 0.94, and US equities: 0.88)3.
“Asian bond issuers also tend to have very low gearing ratios (corporate net leverage) and high interest coverage ratios compared with their peers in the emerging markets and even some of the developed markets. This is one reason why the Asian market has been able to deliver such a high Sharpe ratio over different business cycles, including some major macro events in the past five years,” says Lau, a 32-year industry veteran and co-head of emerging market fixed income at PineBridge4.
Another reason is a strong domestic investor base that understands the market. Strong systematic government support for some issuers, especially state-owned enterprises, adds to market stability.
Meanwhile, the Asian primary market continues to offer robust supply, with new issuances as of the first half of the year surpassing levels in the same period in 2017 and 20184.
POCKETS OF OPPORTUNITIES REQUIRE SELECTIVITY
Over the long term, Lau expects the Asian bond market to remain resilient and attractive to investors. Most investors still lack exposure to Asian credit as global benchmark rules favour developed countries, even though he believes the market is large enough to be considered as a standalone asset class. However, he emphasises that rather than replicating the benchmark, investors need to be deliberate and selective in their approach to avoid taking on excessive risk.
“In this diverse market, it is important to differentiate credit quality among issuers and monitor for idiosyncratic risks,” he says. “We believe volatility will remain elevated in the short term, and therefore, positions will need reviewing more proactively and aggressively.”
As active managers, PineBridge’s award-winning6 Asia ex-Japan fixed income team has the flexibility to invest across the risk spectrum. The team examines the fundamentals, valuations, and technicals to narrow down the most compelling opportunities. Its US dollar Asian investment grade strategy, for example, holds only 162 securities out of over 1,000 issues1 represented in the benchmark.7
In terms of opportunities, Lau says the US-China trade dispute, for instance, is not all negative for investors because the tariff impact differs across issuers, markets, and sectors. While an unfavorable outcome to the dispute could hurt economies like Korea, Japan, and Taiwan, it may benefit others as production shifts from China to Southeast Asia, for instance.
The team also finds select opportunities for higher quality issuers in the fragmented Chinese property sector. Although property sector defaults saw an uptick recently following China’s nationwide deleveraging effort, this is seen as unlikely to become systemic, and the sector’s overall credit quality should improve over time.
Another example is the Indian banking sector. Indian regulators’ recent larger-than-expected capital injection plan is expected to help public sector banks and, in general, the broader banking system in dealing with asset quality and liquidity issues. If implemented effectively, this should present potential investment opportunities in this sector.
“These developments underscore how value can be highly dispersed in Asian bonds, making credit selection especially important. If you can identify those stronger players, you can find opportunities,” says Lau.
Footnotes
1. PineBridge Investments as of 30 June 2019
2. JP Morgan, PineBridge Investments as of 30 June 2019
3. Bloomberg, rolling five-year data as of 30 June 2019. Asia US dollar bonds by the JPM JACI index; emerging markets (US dollar) by the JPM EMBI Global Diversified index; US investment grade credit by the Bloomberg Barclays US Credit index; and US equities by the S&P 500 index.
4. PineBridge Investments as of 30 June 2019
5. PineBridge, JP Morgan, as of 30 June 2019
6. In the Asset Benchmark Research Awards 2018, announced November 2018, Arthur Lau was “Highly Commended” for Asian G3 Bonds in Hong Kong, and PineBridge was ranked 8th Top Investment House for Asset Managers in Asia G3 Bonds. Source: The Asset 2018. For details of methodology, please visit: https://www.theasset.com/research-project/asian-local-currency(Asian Local Currency Bond Benchmark Review); https://theasset.com/research-project/asian-g3 (Asian G3 Bond Benchmark Review). Last assessed 2 August 2019. PineBridge was also awarded Best Asia Bond Fund by the 2019 Morningstar Hong Kong Awards. Source: Morningstar, announced in March 2019. The Morningstar Hong Kong Fund Awards recognise those funds and fund groups that delivered the greatest outperformance, on a risk-adjusted basis, in 2018, and over the longer term. For details of the awards, and methodology, please visit: https://hk.morningstar.com/ap/news/Morningstar-Awards/181968/Morningstar-Announces-Winners-of-2019-Hong-Kong-Fund-Awards.aspx Last assessed 2 August 2019. The above awards are for reference only. It is not indicative of the actual performance of the funds. Investment involves risk. Past performance is not indicative of future performance. We are not soliciting or recommending any action based on this material.
7. The benchmark is the JACI Investment Grade Total Return Index.
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Last updated 22 July 2019