After the low-volatility, low-interest rate, low-inflation environment that defined 2017, Cecilia Chan is pleased to have seen some corrective action already in the early part of 2018. Coupled with the expectation of a more volatile year, HSBC Global Asset Management's fixed income chief investment officer in Asia-Pacific has been formulating her game plan to generate portfolio performance.
Bonds – as well as equities – certainly benefitted from a “Goldilocks” economic scenario last year. Yet the current market landscape makes it easier for investors to choose an appropriate bond yield to invest in and be opportunistic.
More specifically, Chan believes selective Asian currency bonds that offer a good yield against US dollar bonds will continue, more broadly, to remain a strategic holding for investors.
Here, she outlines in greater detail her views on the bond market for this year, on where to find good value for portfolios, on potential challenges for investing in this asset class and on fixed income allocations within portfolios in 2018.
AsianInvestor (AI): What’s your big-picture outlook for bonds in 2018?
Chan: Already in January Treasury yields increased quite significantly – something we hadn’t seen for a while. This was a clear and indicative sign that this year will likely be much more volatile than 2017.
This will mainly be led by valuations, rather than fundamentals, given that the credit and macro-economic environments are still supportive.
There has been some widening in terms of credit spreads, but I don’t expect this to develop into a sustainable trend. Other than a “black swan” event, there is unlikely to be any far-reaching problem to trigger any kind of systematic risk.
It seems as if the market has already adjusted reasonably at the short-end of the US Treasury yield curve in line with these views; we are now assessing at the long-end how steep the curve will be.
One of the areas of concern from a macro perspective is inflation, given that we see inflationary pressure gradually rising.
Net-net, we expect the yield curve to remain positive sloped, but not particularly steep. With the 10-year Treasury yield’s trading range moving up to between 2.7 and 3.2 – and US inflation at around 2%, or slightly higher – this will result in a 1% real bond yield.
AI: Where do you see the main investment opportunities in this market environment?
Chan: This year should be a lot more fun for active managers, enabling them to add some alpha from their active investment strategy.
A key way that we can now add value to portfolios will be from local currency exposure. This plays to our advantage as a financial institution that mainly focuses on Asia, where many currencies have generally under-performed other key global currencies over the past four years.
This has left some room for appreciation in Asian currencies. Further, we are looking to the growth and recoveries in the US and European markets to support Asian exports.
We believe this all bodes especially well for Chinese renminbi, Malaysian ringgit and India rupees.
Another opportunity in the environment predicted for 2018 is for insurance clients. As they look towards more buy-and-hold strategies using longer-dated assets, a rising yield environment is in fact a good thing. It enables us to lock-in higher yields for investors for a longer timeframe.
AI: What key challenges do you foresee for investors in 2018?
Chan: There is still a possibility that interest rates will rise more – and faster – than market participants expect. This is based on some uncertainty from the US Federal Reserve being under new stewardship.
Should this trigger a significant steepening in yield curves, we will have to adapt and shift our strategy accordingly.
A rising interest rate environment in 2018 creates the likelihood for capital loss, although investors might earn more on the carry trade. But if rates rise more than expected, the capital loss will be too great for the carry to compensate for.
China being a big market has been a main investor focus mainly from a regulatory perspective. Saying this, we do not expect there will be any substantial credit events.
AI: How do you see the HKD bond market in 2018?
Chan: The recent weakness of HKD against USD would pressure HKD rates to go higher. Any meaningful increase in HKD rate would encourage some investors to invest in HKD bonds.
Following the rising USD bond yield in the recent months, the HKD bond yields should have rooms to go up to some more attractive levels too.
This will also help those HKD-based insurance portfolios looking to buy long-dated HKD bonds at the higher yield level in 2018.
AI: What’s your view about how to position fixed income within broader asset allocation in 2018?
Chan: Fixed income still deserves to be part of a strategic holding in a portfolio. Whether investors move to being more overweight or underweight the asset class, bonds remain a good tool for diversification, risk balancing and more stable income generation.
Typically, an interest rate hike is considered negative for bonds, yet recent activity has shown it (government bonds) can be a good hedge against a very volatile equity market scenario.
For insurance investors specifically, 2018 should be an opportunistic year. More of these clients are eyeing local currency opportunities, especially Asian currencies in line with a willingness to take a bit more risk and expectation of inflows into emerging markets generally.
For pension funds, 2018 should be a good year for averaging-in, given expected volatility as well as the opportunity to lock-in higher yields. These investors should also look for shorter duration opportunities in the form of high-yield and investment-grade bonds, if their mandates allow. This is in addition to longer-dated assets, for long-term strategic yield carry, as a core holding.
Short-dated bonds with a lower price volatility to interest rate changes make sense for corporates, meanwhile, with a focus on higher yields to ensure a good coupon income and yield pick-up opportunity.
