Arguments for strategic reallocation from developed to emerging market debt and for finding a new safe haven have never been as compelling, asset managers agreed at AsianInvestor’s summit last week in Hong Kong.
Both from a fundamental and a returns perspective, they argued the case for Asian bonds, while seeking to assuage fears over policy-rate risk and the impact of the European sovereign debt crisis on local markets.
Asia’s local currency bond market now stands at $5 trillion in market capitalisation, representing 8% of the global market, noted Kheng-siang Ng, Asia-Pacific head of fixed income for State Street Global Advisors.
Central banks and regulators were working to improve market liquidity, he stressed, extending the maturity of issues and therein offering better reference points for investors, especially at the long end of the yield curve.
Over the decade to April 2011, the total return for Asian local currency bonds has been 8.7%, with a standard deviation of 5.7 and a sharpe ratio of 1.08, compared with US government bonds (return of 5.4%, deviation of 5 and ratio of 1.06) and emerging market equities (return of 14%, deviation of 24 and a ratio of 0.6).
Ng also pointed to the low correlation of Asia’s fixed income markets to the US, at 0.3, as opposed to markets such as Germany, where correlation to the US has risen from 0.56 over a decade ago to 0.8 now.
Asked about the sustainability of this correlation, Ng said it was unlikely to change quickly, given that large institutional investors in the US and Europe were conservative and took time to evaluate Asia. Nevertheless, he said private banks and insurance firms view Asian bonds as promising. “The momentum we are seeing is very encouraging and this asset class will continue to grow.”
This would be helped if markets such as the Philippines and Indonesia were granted investment grade status, enabling pension funds to invest – which Kenneth Akintewe, Asian fixed income portfolio manager for Aberdeen Asset Management, anticipates within 12 to 24 months.
Ng praised the dynamics of Asia’s debt profile when asked whether the views of credit ratings agencies best reflected the global economic picture. However, he stressed that some fund managers needed to show more flexibility and be able to react more proactively to the changing fixed-income landscape. “You need to re-evaluate situations on a year-to-year basis,” he said.
He noted concerns over the potential impact of the European sovereign debt crisis on Asian fixed income, with a telling pull-back from Indonesia’s bond market, which is 30% foreign-owned. Yet he added that investors were quick to pour back in again once valuations hit a certain level.
“We have seen some profit taking [from Asian markets] as the European sovereign debt crisis has came into play. But we have seen bouts of inflows and outflows as investor sentiment shifts. The medium to long-term view for Asian bonds [is] positive.”
In his address, Akintewe said there would be reason to worry about the level of foreign ownership in Indonesia’s bond market if it was dominated by fast-money hedge funds. But he noted that a lot of the inflow had been real money buying into the country’s long-term story.
He noted that authorities had stopped issuing short-dated bills and that Indonesia had one of the lowest debt-to-GDP ratios in the world (20%), with a lack of bonds to satisfy demand. “When Indonesia is upgraded to investment grade, a lot more funds will be able to participate in that market,” he said.
He also noted that volatility in the market had been low despite recent risk events occurring in the Middle East and Africa. “Investors are far less willing to let go of their [Indonesian] bond positions because there is a good chance they won’t be able to get them back again,” he stated.
On concerns over the inflationary environment in Asia and the likelihood of further rate hikes, Akintewe is expecting Asian central banks to hike interest rates by a further 50 to 100 basis points this year in continuation of the policy normalisation cycle. “If you look at a historical chart of the yield, at this point in the cycle you have to admit there are still upside risks to yields moving higher,” he added.
He said it made sense for managers to employ defensive strategies, including inflation-linked bonds, as advocated earlier in the day by Marion Le Morhedec of Axa Investment Managers. Other defensive strategies include interest-rate swaps and managing duration risk.
Aberdeen is advocating local currency short duration Asian bonds. Akintewe noted that the Markit iBoxx 1-3 year Asian sovereign bond index had a pick-up of about 200 basis points over short-dated US Treasury yields.
Both Ng and Akintewe further acknowledged the attractiveness of Asian currency appreciation, dismissing fears that Asian currencies were getting a bit rich.
Ng noted that according to the iBoxx Asian Local Currency Bond Index, Asian bonds returned about 8% from 2002 to 2011, over a third of which was down to currency appreciation and the rest from interest-rate return, coupon growth and decline in yield over time.
While 8% might not be sustainable, Akintewe said the story of Asian currency appreciation still had a long way to play out. He produced a chart looking at the purchasing power parity values of Asian currencies relative to current valuations; it showed Asian currencies were anything from 20% (Singapore) to 60% (India) undervalued.
“For those investors who fear that maybe the [Asia] story is coming to an end or they are late to participate, I can assure them they are not,” added Akintewe. “The story of the global reallocation of capital away from developed markets to Asian markets is still at a very early stage.”
Investors needed to look at Asia’s bond market now, added Ng. “Foreign investors in the US and Europe are beginning to pay more attention to this region. That has been the trend over the last one or two years and we expect that to continue.”