Western Asset fund manager targets corporate bonds
Rajeev de Mello is the head of Singapore operations for Western Asset and portfolio manager of the Legg Mason Western Asset Asian Opportunities Fund. He joined Western Asset Management in 2007 from Pictet, where he had responsibility for managing Pictet’s global fixed-income business out of Geneva.
What is your currency positioning in the fund?
Our biggest position is in the Korean won, which represents an overweight compared with the benchmark and reflects expectations we have for the won to continue to appreciate. It’s one of the more liquid currencies in Asia and had a good run year-to-date, but it’s also more volatile as it reflects global situations and risk aversion.
We are also overweight the Singapore Dollar. The currency is on an appreciation track, partly because of country fundamentals. It is also the instrument which the Monetary Authority of Singapore (MAS) uses to fight inflation and tighten monetary policy.
And we have a sizeable position in the Malaysian ringgit, which has been very strong this year and we think is going to continue. Significant inflows into Malaysia, the credibility of its central bank in terms of hiking rates early and frequently and the reform announced by the government have been good for the currency.
Indonesia is another major holding. We’re overweight the rupiah for a long time and have reduced it close to the benchmark, as the currency is near levels where Indonesian authorities and locals are less comfortable with appreciation. The yield is high on short-dated Indonesian bonds, so we like to keep the currency, but we’re not as aggressively overweight as previously.
We had reduced our position in India in June and took it back up to an overweight in the last couple of weeks. The Reserve Bank of India has been normalising interest rates. The central bank has indicated its commitment to fighting inflation and increasing rates further, if needed.
In Thailand we have a slight underweight. The baht has performed well, but the Bank of Thailand is opposed to further appreciation over concerns that Thailand is losing some of its competitiveness. If the Bank of Thailand wants to slow appreciation, it can; that’s why we’re a bit more defensive.
We’re slightly below benchmark in Taiwan, too. The currency has a relatively low yield, but the slope of the yield curve is quite steep, so we don’t want to be significantly underweight. We also think that if the Chinese yuan is going to appreciate more, the Taiwanese dollar will tend to follow. The Taiwanese economy also has a very large current account surplus and reserves are going up, so that provides further upward pressure.
In terms of risk, we’re also long the Chinese yuan. The currency has appreciated by almost 2 percentage points since the Chinese moved to a more flexible exchange rate in June, which amounts to a 5.5-6% annual rate. We think this is just the beginning in the change and we see this as a major driver in terms of our view for Asian currencies in general.
And how is the fund positioned in terms of country breakdown?
We’re long in Malaysia and Singapore and neutral to slightly underweight in a number of the other countries. The part of the yield curve that we prefer, even in the countries where we are slightly underweight in terms of duration, is the long-end of the curve. We think the short-end can still price in more rate hikes by the policymakers. We’ll be looking to buy the front-end of the curve when we think that enough tightening is priced in. What we’ve been seeing is a very significant flattening in yield curves with the long-end performing very well and the front-end actually weak, as the central banks have been normalising interest rates.
Have you maintained a significant exposure to Asian corporate bond markets?
The exposure to investment-grade corporates is close to the most we’ve had since launch. Corporate bond spreads have tightened quite a bit and that’s helped us in the past couple of months. The high-yield market, where we have a smaller exposure, has become quite expensive. A lot of investors are chasing yields, so we’re a little bit more cautious here. Where we see opportunities, we are buying credit. We’re focusing a bit more on investment grade bonds than in high yield and we think that this rally, in terms of credit spreads, will continue, although not as fast as in the first quarter.
How do you see the global economic back-drop affecting Asian economies, currencies and bond markets?
We think the cyclical recovery in the global economy is underway, although we are going through moderation in growth in the US, Europe and Japan. We don’t think the US will record negative growth figures.
We think moderate growth will continue to be good for Asian currencies and bonds and corporate credit as well. It’ll be good for Asia in two ways. One, if the US implements quantitative easing, the US dollar should weaken and that should be quite good for Asian currencies. On the other hand, if the US implements quantitative easing and government bond buy-backs, it’ll bring government bond yields down and cause a further flattening of the curve.
After an initial normalisation of interest rates, many Asian countries will actually start to get close to pausing their tightening measures. Asian central banks have done something that they’ve never done before, which is to move quite independently of the Fed, European Central Bank and the Bank of Japan in tightening policies. Some Asian countries have brought their policies closer to neutral, but they’re going to be very hesitant to tighten too aggressively. After all, they don’t want to threaten the recovery of the domestic economy. They’ll be especially concerned that Asian currency appreciation will have an impact on their exports.
Finally, the Chinese currency policy change is going to be important for Asia and is going to allow other Asian currencies to appreciate at a moderate pace. These currencies have been appreciating already, but there was a limit as to how far they could go, as long as the Chinese currency remained pegged against the US dollar. At the end of the day, they didn’t want to lose too much competitiveness against China either. What would make Asian currencies perform more is if China really responds to the US demand and starts appreciating its currency at a faster pace. I am quite cautious with my expectations for annual pace of appreciation and some people expect far faster appreciation by China.
In terms of the biggest risks to our outlook, I would mention increased trade protectionism, overheating of Asian economies or a double-dip recession in the US.
Are you concerned about a potential overheating in some of the smaller Asian economies?
In terms of inflation getting out of hand, that could happen. India, of course, has the highest inflation rate among the major countries in Asia right now. It's a risk, but Asian central banks and policymakers attach a lot of importance to keeping inflation low, because they know that inflation actually harms the poor far more than growth benefits the rich. So when they have to decide on a trade-off between, they're very conscious that higher food prices may cost them their jobs. These governments are very concerned about inflation and will hike rates and let their currencies appreciate as well if they feel that inflation is getting out of hand.
On overheating in terms of excessive growth, in an environment where the G3 countries are very weak, there does seem to be opportunity for some of these emerging markets to grow faster than they could have otherwise. Generally, as soon as a country starts growing very fast, it consumes more raw materials and it has to import more. In an environment where there is a decline in demand from the US, Europe and Japan, it actually frees up a lot of these natural resources to go to Asia and to emerging countries, which are more energy-intensive. So I think in an environment of low growth in the G3, it paradoxically allows Asian countries to grow a bit faster than they would have otherwise.
Are you looking to make any changes in terms of your strategy in the fund?
We’ll be looking to increase exposure to short-term maturities (two- to five-year bonds) when we think Asian central banks have reached a neutral point or when we think the market has priced in too much in terms of interest-rate tightening. We aim to maintain our exposure to Asian currencies. We also aim to maintain our corporate bond exposure, as we think current spreads are still interesting in an environment of strong growth, strong cash flows for corporates and stable-to-lower US government bond yields.
Recent reforms have created a new market for Chinese local currency assets in Hong Kong, in addition to the onshore market. Do you plan to use the Hong Kong market?
Over the last couple of years China has allowed Hong Kong residents to build up reserves or holdings in accounts in the Chinese yuan. You could change a certain number of Hong Kong dollars to Chinese yuan every month, or every day. Those are offshore Chinese yuan, which are actually in the banking system in Hong Kong.
Until recently they were placed in accounts at a deposit rate, so earning little interest and not being put to good use. In the most recent reforms, which the Chinese implemented from April and then reinforced again in July, they have started to allow corporates to open accounts in Hong Kong as well, and they have started to allow issuers to issue Chinese currency bonds in the Hong Kong market. It is similar to the Eurodollar market in the ‘70s, which were US dollar-denominated bonds issued in European markets out of London and Zurich.
This is quite a significant step because it means that investors can start investing in yuan-denominated bonds in Hong Kong. Although the market still is small, it is the beginning of a good market. We think that that is going to continue and that will be an avenue for us also to be able to invest in some of the Chinese offshore issues.
We think it is still interesting to invest onshore, because it is a far bigger, more liquid market. The Chinese government has issued some of its bonds in Hong Kong as well, but there are far more in the domestic Chinese market. We plan on using both markets.