Asian bonds: delivering on the demand for diversification
Even though the US Federal Reserve (Fed) signalled a pause to its interest rate hiking cycle when it announced a 25bps increase at its May 3 meeting, much of the developed world remains mired in uncertainty and recessionary fear. This is evident from the expected deceleration in global economic growth.
It’s a different story in Asia, however, where the outlook is much brighter. The IMF’s latest regional economic outlook, released in April 2023, projects Asia will contribute around 70% of global growth in 2023 as its expansion accelerates to 4.6% from 3.8% last year1. The likely drivers are rising demand for consumption from China’s reopening combined with solid growth from other emerging economies in the region.
Asia’s growth trajectory reflects the broader strength at the moment in emerging markets (EM) – and, in particular, the case for EM debt based on the recent resilience in EM economic activity after central banks started to hike rates earlier than their developed market peers.
“Assets in Asia have more attractive valuations than in the US and European markets, and the potential [for Asian bonds] to offer good risk-adjusted returns looks a lot better than it has done for some years,” said Geoffrey Lunt, head of Asia investment specialists, Hong Kong at HSBC AM.
Compelling Asian credits
More specifically, allocations to US dollar (USD) denominated Asian investment grade (IG) bonds, which have a shorter duration than their global peers, have been particularly appealing due to the inverted nature of the yield curve.
For the time being, based on current US Treasury yields, investors might continue to be interested in USD Asian bonds, said Lunt. “They can still get extra spread from investing in these high-quality markets.”
Notably, the opportunity set in the region contains a mix of national champions, large Chinese state-owned enterprises and state-owned banks, and quasi sovereigns and global conglomerates from the more developed parts of Asia including Singapore and Korea. Typically, these types of issuers are not prone to defaults or becoming fallen angels.
“These trends make Asian IG credit a legitimate diversifier in global portfolios,” added Lunt. “They are possibly an even better option in the current macro environment.”
In the sustainability spotlight
Another drawcard for Asia is the evolution and popularity of green, social, sustainable, and sustainability-linked (GSSSB) bonds.
“The majority of bonds now being issued in the USD space from Asian issuers have some sort of sustainability characteristic,” said Lunt. “The market’s potential is already being realised.”
There is notable market support for GSSSB issuance in 2023. While 2022 saw an inevitable decline in the volume of labelled bonds given the global reduction in issuance as bond yields soared, S&P Global Ratings, for example, expects this year to see a return to growth – reaching between US$900 billion and U$1 trillion, nearing the record US$1.06 trillion in 20212.
Among the factors likely to fuel this are policy initiatives, levels of investment in climate adaptation and resilience and the ability of issuers to address concerns about the credibility of certain types of GSSSB debt.
Reliable returns in Hong Kong
The larger environmental, social and governance (ESG) dimension to an increasing portion of HKD bond issuance is also potentially broadening the appeal of these assets going forward.
For example, in mid-February 2023 the Government of the Hong Kong Special Administrative Region issued the first tokenised green bond by a government globally, with a HK$800 million (US$102 million) offering under its Government Green Bond Programme.
Hong Kong’s general commitment to promoting green initiatives is clear from the 2023 budget, also released in February. This included plans to transform the city into an international centre for green technology, with HK$15 billion of green bonds earmarked.
Meanwhile, the insurance industry in Hong Kong is currently proposing to regulators that it obtains more favourable capital treatment for green assets. If accepted, there should be even more demand for sustainable bonds, and more incentive to issue.
Combined with the economic tailwinds as part of the post-Covid rebound, the HKD bond market will remain an important market for local institutions and big conglomerates with a locally listed subsidiary aiming to manage their HKD exposure, explained Lunt.
Further along the risk spectrum, investors can expect to find opportunities on a selective basis in higher yielding markets like India, Indonesia and China credit.
While bondholders are still reeling from the effects of the 2021 real estate collapse in the latter, it is gradually becoming clearer to see which property developers are most likely to survive the market overhaul. For the stronger names, Lunt believes that the dislocation of the market and distressed pricing levels can potentially create some healthy gains.
More broadly, China represents a unique opportunity as it moves further along its post-Covid reopening path, buffered by its relatively low levels of inflation compared with other parts of the world. “This allows for looser monetary policy that can be focused on those parts of the economy that are struggling,” added Lunt.
Growth is re-emerging, too. China’s economy registered 4.5% growth in GDP in the first quarter of 2023, according to its National Bureau of Statistics – marking the highest growth since the first quarter of last year as well as quarter-on-quarter growth of 2.2%3.
Meanwhile, in India and Indonesia, robust fundamentals suggest promising medium- to long-term economic prospects.
Among the sectors attracting most attention, Lunt pinpoints Indian renewables, given the potential for greater issuance over the coming years as the transition to a lower carbon economy calls for significant capital markets funding. Indonesia is well-placed to follow India’s lead.
Gaining an Asian appetite
Despite these and other themes in the IG universe, however, global investors are not yet convinced about Asian fixed income exposure to the extent that Lunt believes they should be.
He sees some nervousness among investors outside of the region when it comes to Asian credit, as a result of geopolitical tensions over the past 12 to 24 months, therefore limiting appetite for the asset class.
He is optimistic this will change in time. “As markets stabilise and show they can produce good, non-correlated returns, we will start to see a return of interest from global investors.”
1 - https://www.imf.org/en/Publications/REO/APAC/Issues/2023/04/11/regional-economic-outlook-for-asia-and-pacific-april-2023
2 - https://www.spglobal.com/_assets/documents/ratings/research/101572346.pdf
3 - https://www.cnbc.com/2023/04/18/china-economy-q1-gdp-2023.html
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