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Asian fixed income: local currency bonds’ strong comeback

A sell-off in emerging markets at the end of last year has reversed – and long-term economic factors are driving the change, according to Matthew Arnold of State Street Global Advisors.
Asian fixed income: local currency bonds’ strong comeback

Investors are returning to emerging market bonds, including Asian bonds, after a sell-off towards the tail end of 2016 following the election of Donald Trump as US president. Asia’s economic resilience, relatively better credit outlook and potential foreign exchange gains are among the top reasons why investors are flocking to Asian local currency bonds.

Demonstrating this trend, the ABF Pan Asia Bond Index Fund (PAIF), Asia’s first exchange-traded bond fund, has returned 3.1% year to date (28 February 2017) compared to 1.9% for the Bloomberg Barclays Global Treasuries Index [1].

Matthew Arnold, Head of ETF Strategy and Research APAC at State Street Global Advisors (SSGA) explained, “There was a rotation out of the emerging markets, particularly on the bond side, into US assets at the end of last year, but investors have perhaps realized the sell-off was overdone and flows are now swinging back the other way again.”

“This positive sentiment towards emerging market countries generally has also been bolstered by recent earnings releases and signs of improving economic fundamentals,” he continued. “We’re seeing export growth from key markets like Korea and Taiwan, and that has reinforced the belief that global growth is recovering. We will see how the year pans out, but it might even approach long-term trend levels, which is very welcome after years of sub-par economic growth.”

While short-term performance has been encouraging, it is the long-term case for EM fixed income that has been the major driver of flows, certainly from institutions such as pension funds.   

Arnold noted how European investors, in particular, have become increasingly keen to allocate to emerging markets local currency bonds in recent years.

“Investors the world over have suffered in this low interest rate environment, perhaps none more so than European institutional investors with large allocations to fixed income,” he said.  “The attraction of emerging market local currency bonds for them is clear. Aside from offering significantly higher yields, European investors stand to benefit should emerging market currencies continue to appreciate relative to their home currencies.”  

For example, sterling-based investors in PAIF would have generated returns of approximately 7.5% annually since the fund’s inception in July 2005, while US dollar-denominated investors would have returned only 4.4% annually [2]. This reflected the strength of the dollar in recent years, which, Arnold said, had been a headwind for dollar-based investors in Asian local currency bonds.

However, since the start of 2017, the dollar has declined against a broad basket of currencies, as doubts emerge over how swiftly President Trump can implement his “America First” agenda of infrastructure spending and tax cuts. 

Over the longer term, Asia’s strong fiscal and monetary dynamics relative to the rest of the world remains a chief attraction for investors in Asian local currency bonds. The average debt-to-GDP ratio of G7 countries is about 120%, almost 3 times the average level of the eight countries that make up the Markit iBoxx ABF Pan Asia Total Return Index tracked by PAIF (China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand).  Moreover, Asian sovereign credit ratings are also generally improving unlike those of developed markets. Only Indonesia still has a sub-investment grade credit rating within PAIF, but that BB+ rating is on the cusp of investment grade status as it is on a positive outlook.

China is a key driver of the Markit iBoxx ABF Pan Asia Total Return Index and over the past 15 years, has been the single best-performing individual country within it, followed by South Korea and Singapore. China is likely to become even more important as it opens up its US$6.36 trillion domestic bond market to foreign investors, removing the last barriers to full access.

“The region’s favorable fundamentals and growing opportunities for the asset class offer compelling reasons for a range of investors to continue to seek exposure into Asian local currency bonds over the long term,” said Arnold.

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[1] Source: Morningstar Direct. Total return (net of fees for PAIF) in USD as of 28 February 2017. Past performance is no guarantee of future results.

[2] Source: Morningstar Direct. Total annualised returns since inception (7 July 2005) for PAIF in GBP and USD, ending 28 February 2017. Past performance is no guarantee of future results. 



This material may not be reproduced, distributed or transmitted to any person without express prior permission and may not be distributed and published in jurisdictions in which such distribution and publication is not permitted. PAIF is an authorized unit trust in Hong Kong and Singapore only. Authorization does not imply official recommendation. No action has been taken to permit an offering of units in PAIF other than those listed above. Past performance of PAIF is not necessarily indicative of its future performance. The prospectus for PAIF is available and may be obtained from State Street Global Advisors Singapore Limited (the “Manager”) (Singapore Company Registration number: 200002719D, regulated by the Monetary Authority of Singapore) and authorized participants. The value of PAIF and the income from them, if any, may fall or rise. The semi-annual distributions are dependent on PAIF’s performance and are not guaranteed. Redemption of PAIF’s units could only be executed in substantial size through designated dealers and the listing of PAIF on the stock exchanges do not guarantee a liquid market for the units, and PAIF may be delisted from the stock exchanges. PAIF may use or invest in financial derivatives. This advertisement is issued by State Street Global Advisors Singapore Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong (“SFC”).

The views expressed in this advertisement are the views of Mathew J. Arnold through the period ended 27 March 2017 and are subject to change based on market and other conditions. This advertisement contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.

All forms of investments carry risks, including the risk of losing all of the invested amount. Such activities may not be suitable for everyone.

Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates rise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Diversification does not ensure a profit or guarantee against loss.

ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns. Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.

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