Asian institutions embracing emerging market bonds

Patrick Chia, Singapore-based associate director of fixed income, managing Credit Agricole Asset Management's fixed-income assets in Asia, including portfolios of Asian bonds, balanced funds, global bonds and local money market funds. He also works with CAAM's London desk to manage an absolute return fixed-income fund.

FA: What's the firm's fixed-income investment philosophy?

Chia: In the long term you can't predict market direction, so the optimal way to manage the fund is in portfolio construction. We use variance and covariance methods - looking at currencies, G7, emerging market bonds, equities, and analysing their correlations. We run thousands of asset combinations using these metrics. We have a full team in Paris just doing this. We use this data to put assets into fixed-income portfolios. Each asset has its own risk, but the total portfolio risk is much less.

The key thing for us is diversification. We use normal distribution with volume at risk (VAR) to determine how much risk a portfolio can take. If you depend on Fed cuts or euro movements to manage a portfolio, it's a headache. We take bets, of course, but on all sorts of things. The fund manager has to get most of the things right but not everything.

Does this represent a change for the firm?

Our investment strategy has evolved. In 1998, for example, we realized that certain bets we were taking were too much; we were too dependent on just a few bets, and it wasn't worthwhile for the clients. So we've moved away from that. Now we put more into a portfolio, and analyse the risks and returns more closely. Since then we've been getting a lot of new money into our portfolios, particularly in London. We do short-term tactical trading. While for some managers this is the main strategy, for us it's one of many aspects of diversification.

So is your methodology like a black box?

No, not at all. Team spirit is very important, and there's a lot of qualitative input. We ensure that for every asset, we can quantify all our risk and its relationship with other assets, so we know where we are - that's one half. The other half is teamwork. We have an economics team in Paris and we're dependent on them for fundamental research. We have quarterly meetings with them to produce the house view. Broker research is also important.

What's the quality of broker research like?

The industry has maintained its research standards. Some of it is excellent. Deutsche Bank is very good. So are Merrill Lynch and UBS. We'll take our house view and compare it to the brokers. This doesn't mean we'd change our view if it's different, but it's good to know where we stand. We also work closely with our asset management equity team in Asia and go with them to meet companies.

What do you get out of company visits?

It's very hard to know everything from a company visit. They won't tell you everything. We also depend on what other companies in the industry think. We look at the equity price. We need information from all kinds of sources.

Should investors stay in bonds?

Treasuries are overvalued. Fundamental interest rates are expensive. We're advising our clients to invest more in emerging market bonds, and diversify via currencies; or use our Libor fund, which is designed to deliver an absolute return. We run two emerging bond market funds, one out of London, as well as an Asian income fund, which is now returning 11.5%.

What are the risks of staying overweight fixed income?

The stock market still has room to run in Asia. The US stock market is not cheap, but may continue as it is. So if stocks are stable or moving upwards, the Fed is not going to hike interest rates. This is the best market for emerging market bonds. A lot of money has already moved into that asset class, but it's just a start. Spreads on emerging market paper will tighten further.

There is a correlation between equities and emerging market bonds. Why? For high-yield bonds, the important thing is the credit, not the interest rate level. What we look at is the ability to pay. Equities can show us if a company is sound, if the environment is conducive for its credit standing.

The last three years of bear markets changed the attitude toward equities in Asia. People have become a bit frightened. But more and more are asking for emerging market bonds. We see more private bank clients moving money there.

Do you participate in new issues?

Yes, I do, in order to get a feel for the market, as well as to diversify. Spreads can be quite big on Asian emerging market issues, but I buy from the underwriters outright. And you can't always buy high-yield issues if all the private banks are also buying it, so a new issue can sometimes give you want you need.

What's the record lately for new issues from Asia?

The record is good. Indonesian issues were quite well received. Bank Mandiri's a good example. Korea has been okay but there's been a lot of issuance - maybe too much. Companies like Woori Bank are finding it a good time, but I think the market's suffering from a bit of indigestion.

What's the tactical focus now?

The Fed and short-term rates. It could be a quiet summer if the stock markets rise and we see consolidation in the bond markets.

Should Asian institutions increase their euro exposure?

Over the past few months, a lot of Asian investors have been looking to diversify their mostly dollar holdings. Partly because of the euro's strength, but we still see more value - it's still not expensive. The euro issues of Asian institutions such as Petronas and Republic of the Philippines have seen a lot of demand both by regional investors as well as by private banks.

Broadly, I see more central bank and pension fund demand in Asia for cash and absolute return as well as for euro-denominated funds. Many Asian institutions are putting money into the Libor-return concept. Now we're seeing more interest from private banks as well, and we've been rolling out pooled products for institutions. We may consider offering similar products to Asian retail investors later.