Asia fixed income exchange-traded products have driven record inflows into the product class this year as investors seek income diversification to counter volatility and rock-bottom interest rates.

Overall $105 billion was channelled into all classes of ETPs in the first six months of 2012, a new high and a 16% year-on-year increase on $90.6 billion in the first half of 2011. The global ETP industry stood at $1.68 trillion in size as at June 30.

Of this inflow, fixed income ETPs accounted for $42 billion, or 40%, of net new assets – a 114% increase on the same period a year ago. The 32 locally listed fixed income ETPs in Asia Pacific have now reached $5.6 billion in AUM, a 21% year-on-year hike.

Janice Wu, managing director at State Street Global Advisors (SSgA), notes that global investors favour Asian fixed income ETPs due to the appreciation potential of local currencies and generally higher yields than developed markets.

According to an SSgA study, the annualised total return on Asian local currency bonds stands at 8% historically, of which currency returns contribute 2.6% and market returns 5.4%.

Over the last decade Asian local currency bonds have offered the highest risk adjusted return (Sharpe Ratio 0.91) and relatively low beta to the S&P 500 (0.16) as against European government bonds, US Treasuries, emerging market equities and US equities, finds SSgA.

In terms of size and liquidity, Asian local currency paper has almost tripled over the past five years to about 8% of the world’s bond market, according to the Asian Development Bank.

Wu notes that while developed market bonds still make up the core of global investor holdings, increasingly Asian bonds are being seen as a key diversifier in terms of currency and regional exposure.

She also views a number of developed country sovereign bonds as overvalued. “US Treasuries are a safe haven now. However, while the price is going up the yields are very low. Investors who seek sources of income are shifting more towards Asia, diversifying away from potential risk from the ‘fiscal cliff’ in the US.”

As at 30 June, SSgA’s ABF Pan Asia Bond Index Fund (PAIF), the first Asian bond ETF, had achieved $3 billion in AUM. Its annualised total return since inception in June 2005 is 7.52%, and it had a total return of 4.68% for the past 12 months.

PAIF tracks the Markit iBoxx ABF Pan-Asia Index and is registered in Singapore and listed on both the Hong Kong and Tokyo Stock Exchanges. It invests in sovereign debt of China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand.

“Demand for exposure to fixed income assets has been a key theme for the past year and shows no sign of abating, as acceptance of the value of an indexed approach to fixed income investing gains increasing traction amongst investors,” Dodd Kittsley, global head of ETP research at BlackRock, commented earlier this month.