The tightening of US monetary policy and other global disruptions have slowed the growth of the local bond markets in East Asia’s emerging economies, prompting investors to seek alternative solutions during this period of market volatility.
The growth of local currency (LCY) bonds in these markets in the first three months of 2022 slowed to 3.1% quarter-on-quarter to reach $23.5 trillion at the end of March, according to an Asian Development Bank (ADB) report released on June 27.
The report cited weakened financial conditions and global economic headwinds such as inflation and supply chain disruptions as reasons for the slowdown.
Bond issuance also took a hit, falling 6.5% from the previous quarter as inflationary pressure and tightening financial conditions pushed up bond yields in the region’s emerging markets (EM), which include China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, Thailand, and Vietnam.
IN SEARCH OF HIGHER YIELD
Against this backdrop, several institutional investors who spoke to AsianInvestor believe the worst is not over for LCY bonds as monetary conditions are likely to tighten further with more Asian central banks expected to join the US in raising interest rates to fight inflation.
These investors have offered solutions that include private credit, value equities in developed markets (DM), and Asian investment grade (IG) bonds as well as selective short-duration LCY bonds.
“The reason we prefer private credit is because the fund manager has the flexibility to drawdown the capital during the two to three year investment period and can take advantage of dislocations in the market better,” Prabhat Ojha, managing director and head of Asia client business at Cambridge Associates, told AsianInvestor.
Another advantage, he added, is private credit fund managers can enhance structural protection on loans and bonds they invest in and are better equipped to resolve any credit issues that arise.
“We would not overweight high yield or other high-risk credit products, given that there will continue to be volatility as the recessionary fears play out over the coming quarters,” he said.
On equities, he favours value and high-quality stocks in developed markets as they offer better prospects in a high inflation environment or recession, although he finds Chinese equities have attractive valuations compared with their peers in other markets.
Desmond Soon, head of investment management for Asia (ex-Japan) at Western Asset Management, a specialist investment manager of Franklin Templeton, advocates a cyclical defensive strategy based on short-duration bond portfolios and bond ladders – buying bonds with different maturity dates – while locking in longer-dated higher bond yields when the inflation cycle peaks.
“On the Asia LCY government sector (local currency universe), our picks are shorter-dated government and quasi-government bonds in Indonesia (for yield), China (for attractive DM-like yield and diversification benefits) and Singapore (for DM-like yields and trade-weighted relative FX appreciation potential),” he said to AsianInvestor.
He also favours high-quality Asia and international bank capital securities, issued in Asia local currency, for their attractive yields.
Arthur Lau, head of Asia ex-Japan for fixed income at PineBridge Investments, prefers US dollar-denominated Asia investment grade (IG) bonds for their better track record in delivering higher returns with lower volatility than US IG credit and EM bonds.
He told AsianInvestor that the risk-adjusted returns of Asia IG bonds have outperformed US IG credit, US inflation-linked bonds, and EM bonds over a five-year period, making them an ideal diversifier in volatile markets.
“Valuations are attractive, and Asia IG’s stable fundamental credit outlook means credit spreads could provide an additional cushion against any further tightening and economic slowdown,” he said.
SUSTAINABLE BONDS BUCK THE TREND
Amid the gloom in the wider bond market, the sustainable bond sector in Asean+3 – the 10-member Southeast Asian grouping and China, Japan and Korea – grew 9.7% in Q1 2022 to reach $479 billion at the end of March, according to the ADB report.
The buoyancy in the sustainable bond market does not surprise Lau. “Undoubtedly, sustainable bonds are emerging to be a standalone asset class within the fixed income universe that warrants a dedicated allocation,” he said, adding that investors, wary of greenwashing, would be willing to pay a green premium for bonds that are “true to label.”