Asian HNWIs fret about fixed-income portfolio outlook

A rising interest rate environment and tight credit spreads remain front and centre for fixed-income-loving wealthy investors, say private bank experts.
Asian HNWIs fret about fixed-income portfolio outlook

Wealthy Asian investors are concerned about the potential impact of rising interest rates on their fixed income-heavy portfolios as they head into 2018, according to private bank advisory and investment experts, given a historical tendency for bonds to perfom less well when monetary policy is tightened. 

So with US rates going up for the third time this year on Wednesday (December 13), three more US hikes projected next year, and the dollar still the world's main currency, those concerns could yet spur demand for higher-yielding assets such as equities and alternative investments, experts say. 

“Wealthy Asian investors tend to have a disproportionate level of fixed income in their portfolios, and conservative investors even more so,” Aman Dhingra, head of advisory for Singapore at UBP, told AsianInvestor.

Fund selectors, advisory chiefs, and discretionary managers AsianInvestor speak to estimate that on average at least 60% of the portfolios of held by Asia's high net worth individuals (HNWIs) consist of fixed income assets.

"For fixed income-loving investors, their safe haven [assets have] become way too expensive—that is the chief concern," Dhingra said. 

Worries about rising interest rates and their impact on bond investments is partly the reason why some investors are also handing portfolio management to professional managers, according to Tan Wei Mei, head of portfolio solutions for private banking Asia Pacific at Credit Suisse.

"With the interest rate cycle starting to turn, many investors are realising that it’s going to be harder to manage their portfolios,” she told AsianInvestor. “That is why more recently, we have seen an increase in allocation towards fixed income discretionary mandates

Fixed income markets are also influenced by how credit spreads behave.

Credit spreads—usually the difference in yield between government and corporate bonds—are tight across the credit-quality spectrum and across different maturities and segments including contingent convertibles and high yield debt. 

Tighter spreads typically indicate growing economic optimism but in recent years spreads have been driven down to extremely low levels by super-low interest rates and the bond-buying actions of major central banks as these have sought to revive growth in the wake of the global financial crisis. 

What that suggests is that risk has not been priced appropriately in credit markets. So one mis-step by a company can potentially trigger a dramatic reaction in bond markets, experts say.

It is also why the Federal Reserve, European Central Bank, and so on have to proceed very slowly now they have begun, or are thinking about, reversing their ultra-loose policies.

In this environment, any market-disrupting event can lead to a double whammy effect, with investors hit both as rates normalise and spreads widen (and bond prices, which move inversely to yields, fall), Dhingra said. "An investor stands a good chance of the bond seeing equity-like downside risk."

Risk of price erosion

In their search for yield, income-starved investors have in recent years been moving into riskier fixed income assets.

“Many have embraced more credit risk, spurred by negative rates in many developed market economies and low yields on perceived safe-haven assets," Blackrock Investment Institute said in its global investment outlook for 2018.

“Investing in higher-yielding but often illiquid credit and selling [equity] options can be self-reinforcing, driving volatility lower on the way down but exacerbating any reversals on the way up,” it cautioned. 

Many Asian yield seekers have also gone up the duration curve, taking exposure to seven, eight-, nine- and 10-year bonds, Dhingra said. Longer duration bonds are more vulnerable to interest rate changes.

But the outlook for global bond prices, according to most asset managers, is subdued. Macquarie Investment Management, for instance, expects a muddle-along kind of year for bond prices, where recession risk is low but the upside is contained. It forecast rates would remain range-bound, with the benchmark 10-year US Treasury bond yield likely to stay between 2% and 2.6%.

Equities, alts to gain 

Overall, both UBP's Dhingra and Bryan Goh, chief investment officer for Singapore at private bank Bordier & Cie, expect portfolio returns to be lower in 2018 compared with this year, mainly due to a weaker performance on the fixed income side.
"The equity portion of portfolios could return higher or lower compared to this year’s returns, but the fixed income portion will definitely offer lower returns,” Goh told AsianInvestor.
So overall it will still be lower, which is why there is a greater impetus to move into equities and alternatives. Even on a balanced portfolio with a 50:50 allocation to bonds and equities, for instance, Goh said he expects overall lower returns on the portfolio. 

“If investors have a targeted return portfolio, that will entail a greater shift into equity, when valuations are relatively high across the board," Goh said. “It also means they need to be prepared to go up the risk scale, and [that] requires an assessment whether they have an appetite for that.”

He expects to increase allocations to hedge funds in the private bank’s discretionary portfolios in 2018. “We were quite heavily invested in hedge funds three years ago, then we took it down to single digits. Now we are building it up back again,” he said. 

Dhingra, who also heads the fund slelection team at UBP, said investors have shown some interest in emerging markets debt but they need to be mindful of the impact a potentially stronger US dollar could have on emerging market assets. Traditionally, a strong dollar has led to weaker demand for emerging market assets.

“We might consider short-duration EM strategies [for discretionary portfolios],” he said.

He also said he expects a pick-up in investor interest in alternatives next year as staying invested in traditional fixed income becomes trickier: “We plan to reduce the leveraged loan exposure [in portfolios], and some of that money will likely be allocated into private debt.”

An AsianInvestor report on December 6 noted that private debt markets are well placed to extend their boom for a second decade, especially if global interest rates and credit spreads stay relatively depressed.

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