Rising Sino-US tensions should not deter Asian asset owners from allocating more to Chinese bonds over time, but they are likely to favour developed market sovereign bonds over emerging market debt amid the current turmoil, says Invesco’s head of Asia Pacific fixed income.
Freddy Wong cited concerns over the impact of investment and trade disputes on China’s economy and big recent outflows from emerging market debt driven by the Covid-19 pandemic. But the asset class has become “quite cheap", he added, so Asian investors are consequently unlikely to reduce their exposure much more.
Wong was speaking to AsianInvestor ahead of the release of Invesco’s global fixed income study today (May 18). Thirty-nine of the 159 investors polled – which included pension funds, insurers and sovereign wealth funds – were based in Asia Pacific. They accounted for $5.1 trillion of the $20.3 trillion managed in total by the respondent firms.
Crucially, though, the US fund house's third such annual study was carried out in October and November, before the coronavirus outbreak took hold this year.
Asia Pacific institutions’ average allocation to Chinese fixed income is 6.1%, double that of their peers in North America and Europe, the Middle East and Africa, according to the report. And Asia Pacific asset owners said they expected to raise their China bond allocation, on average, to 7.6% within three years.
Asked whether the US-China tensions would affect plans to allocate more to Chinese bonds, Wong said investors should be pragmatic. “They have to realise that, if you want growth, this is the area that you can get [it].”
The yields on Chinese 10-year government debt and triple-A corporate bonds were 2.67% and 4.135%, respectively, as of May 15. US 10-year treasuries were yielding 0.64% at the close that day.
US-CHINA TENSIONS RE-IGNITE
Moreover, China will post 1.2% GDP growth this year and 9.2% in 2021, the International Monetary Fund forecast in early April, as against a -3.0% GDP fall globally. However, IMF head Kristalina Georgieva this month warned that the agency may revise its growth figures downwards again, on the basis of more recent data and the potential for a rekindling of the trade war between the US and China.
American president Donald Trump this week further ramped up his rhetoric blaming Beijing over its Covid-19 response, threatening to cut ties with and curtail US investment into China.
Indeed, the Federal Retirement Thrift Investment Board on May 13 halted a plan to shift some $50 billion of its $600 billion portfolio into stocks mirroring the MSCI All-Country World ex-US index. Chinese companies make up 7.6% of this benchmark.
Such issues may help explain why 32% of Asia Pacific investors with allocations to Chinese bonds cited political risk as their second biggest concern, after investment risks such as volatility and defaults (47%), according to the survey.
There has not yet been a substantial slowdown in allocations into Chinese fixed income, Wong noted, but the near-term outlook is gloomy because of the pandemic.
Indeed, Wong said he was more worried about the impact of the pandemic on China’s economic growth and, in turn, on allocations to Chinese bonds. The country’s GDP shrank 6.8% in the first quarter.
EM DEBT OUTFLOWS
Certainly, there is a grim outlook for emerging market debt overall, despite a 23-percentage-point increase in the share of investors with allocations to these assets compared to three years earlier. The study found that 89% of Asia Pacific investors have allocated to EM debt and 63% preferred country-specific EM allocations for better returns.
Wong said he expected the number of Asia Pacific investors allocating to emerging market debt would drop in favour of traditional safe-haven assets such as developed market sovereign bonds. There have been net outflows from emerging market debt globally over the last two months or so, he added.
In fact, the first quarter of 2020 saw the largest ever quarterly outflow of foreign portfolio capital from emerging markets (across debt and equity) – $62 billion – said the Institute of International Finance in early April. And there may be more such redemptions this year, the IIF added, given the potential fallout from Covid-19. That said, most of the withdrawals were from emerging markets other than China.
Moreover, searches for emerging market fixed income managers fell during the first quarter of 2020, according to consultancy Bfinance. They accounted for 8% of all searches globally in that period, down from 15% in the first quarter of 2019. Investment grade bond manager searches made up 67% of the total in the first quarter of this year, up from 46% in 2019.
This has come amid poor performance. The Bloomberg Barclays EM USD Aggregate Total Return Index fell by nearly 11% in March alone, and was down 5.97% for the year as of May 15.
And the outlook is not encouraging. Rating agencies such as Fitch and Moody’s have warned of potentially record defaults by emerging market sovereign and corporate borrowers in the coming months thanks to the coronavirus-related disruption and market dislocations.
On top of that, fiscal stimulus rolled out by the governments of emerging markets could also put pressure on their balance sheets, Wong said, creating a financial burden if they were to recover slower than expected.
Joe Marsh contributed to this article.