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What does the global financial crisis mean for AsiaÆs fixed-income market?
Hui: Financial markets are all inter-related. It is quite clear now that there is no decoupling either in the Asian economies or financial markets. The deleveraging process in the US banking and household sector are disinflationary, and the credit cycle eases pressures in many commodities.
Together with lower economic growth in the region, most central banks in Asia have become less hawkish. In currencies, Asian central banks in general have less incentive for strong currencies as growth slows down and inflation concern eases. In credits, Asian banks and corporates are generally less geared, and fundamentals are less affected by the mortgage and property markets in the developed world.
We expect lower default rates in Asia than US for this cycle. Having said that, the Asian credit market lacks depth and many investment participants are financial institutions with global operations. We do expect Asian credit markets to continue to follow the market trends in the US, but Asia will outperform after the stabilisation of global financial markets.
How have you been dealing with the impact of the credit crisis, in terms of managing your Asian fixed-income portfolio?
Given the very volatile market conditions, we have moved to capital preservation mode with the aim of upholding the fundÆs absolute return objective. Since the start of the credit crisis in the second quarter of 2007, we have substantially lowered our exposures in high-yield corporate credits as this sector has the highest sensitivity to the US credit and banking crisis.
As banks struggle to raise capital and liquidity in the market, liquidity is of top priority. We focused on liquid sectors such as US Treasuries and German Bunds, certain local rate markets, and Philippines and Indonesia USD sovereign bonds. At a very volatile market environment, we believe it is important to hold positions that are liquid, so we can tactically change our investment strategy as the market moves. While correlations among asset classes rose, security selection remained very crucial for our investment process, as the market penalised sovereign and corporate credits that have heavy short-term funding needs.
What has been the impact of the credit crisis on Asian currencies?
Asian currencies are expected to be undermined by a weaker economic growth profile, lower inflation (which reduces policy need for strong currencies), as well as relative underperformance in the Asian equity markets. Structural short-USD trades accumulated over recent years by real money and retail investors, both in Asia and globally, may still need some time to be shaken out before the recent USD rally gets a breather. We have reduced most of our Asian currency exposures in our Asian bond portfolios and will keep non-USD exposures at low levels in the near future.
What has been the impact of the credit crisis on Asian interest rates?
The dislocated global interbank markets are spreading to Asia with banks in HK and Singapore reportedly hoarding cash and unwilling to conduct term interbank funding. On the other hand, the decline in oil prices will benefit selected Asian local currency markets which have already discounted the headline inflation shock e.g. Indonesia. Amidst an overall jittery risk asset global backdrop, our portfolios will maintain small exposure to these selected Asian local themes but the positioning will not be aggressive.
What is the mix of your overall Asian fixed-income investments?
The recent collapse in risk-free global government bond yields to historic low levels, signalling extreme flight-to-quality circumstances, have made us wary of duration risks in the medium term. In particular, the Treasury TARP will necessitate substantial issuance of US Treasury bonds ahead. In the near term, however, with the likely continuation of the global credit crunch (despite the planned bailout) and high global recession risks, our Asian bond portfolios have tactically increased duration via US Treasuries.
Overall, we believe there are more opportunities in credits than interest rates and currencies in the next 12 months. Our strategic view is that Asian credits should present solid buying opportunities over the coming 12 months. We are evaluating a lot of credit opportunities now and plans to gradually look for opportunities to add fundamentally sound credits with very attractive valuations. However, amid the still poor market technical conditions, we remain currently defensively positioned in corporate credits in the near term. Meanwhile, we are maintaining a defensive stance by increasing our cash holdings to around 20% and focusing on the major liquid local government bond markets and diversifying part of the portfolio into US Treasuries and German Bunds.
Do you have a preference for short-term or long-term Asian fixed-income instruments?
Except Korea and Malaysia, we generally prefer longer-dated paper.
Do you have a preference for corporate or government bonds?
In the near term, we expect certain government bond markets (such as G3) to continue benefiting from flight-to-quality flows and these bond markets are very liquid, while corporate credit spreads may continue to widen out to reflect a weakening of global economic growth and a pick-up in global default rates. However, corporate credits have already priced in a lot of downside risks, and we expect this asset class to become attractive again in the next 12 months.
Do you have a bias towards investment-grade bonds, given the uncertainty in global financial markets?
Investment grade bonds are generally more defensive, especially during periods of market uncertainty. However, we still have to be very selective. Many bank and quasi-sovereign credits that carry investment grade ratings have suffered more than certain high-yield credits that benefit from domestic consumption in Asia and commodity prices. Liquidity and refinancing risks are the key drivers here, and our credit analysts focus on picking credits that have little near-term refinancing burden, and avoid credits that rely on short-term funding. In the sovereign sector, performance in short-dated USD Philippines sovereign bonds which benefit from strong local bids have been more resilient than Korea quasi-sovereign paper as it has heavy refinancing requirements.
Do you have a stronger view towards a particular fixed-income market in Asia?
No strong views at the moment, but we find Korea (offshore funding squeeze may translate into higher onshore borrowing costs) and Malaysia (larger than expected fiscal deficit may translate into supply risks) least attractive.
Has the current turmoil increased the demand for Asian fixed-income instruments?
This depends on whether the particular Asian fixed-income instruments can benefit from risk aversion. Risk aversion tends to benefit some defensive local rate markets such as Singapore. However, credit markets in Asia especially in banks and high-yield corporate remained nervous and hence dampened appetites in Asian corporate credits.
Globally, fixed-income funds have been registering strong net inflows compared with equity funds. Is this trend the same for Asian fixed-income funds as well?
We continue to see decent interest in Asian fixed-income funds. Historically, Asian fixed income as an asset class has a low correlation to equity markets, and hence provides a good diversification vehicle for investors.
One of the most common criticisms of global fund managers is the lack of depth in secondary fixed-income markets in Asia. How are you able to find value in the market under such conditions?
Yes, there is a lack of depth in secondary fixed-income markets in Asia but we have seen significant improvements over the past few years. There are a rising number of participants in the US dollar Asian credit markets given the relatively strong growth in Asia and attractive relative value in Asian credits against the US markets. On the other hand, more corporates are tapping into the bond markets across rating spectrums as they see the need to diversify their funding sources from the traditional bank loan markets. In local rate markets, central banks and governments in Asia are actively developing the local government and corporate bond markets.
There is no doubt that the current turmoil in the credit markets has made the market environment very challenging, but it also presents attractive investment value for long-term investors. Due to liquidity conditions in the bond market, many decent credits were sold off aggressively and have more than discounted their expected default risks.
What have been the main challenges you have faced in managing an Asian fixed-income portfolio over the past 12 months?
Liquidity has dried up quickly in the credit markets, making the market too illiquid for portfolio managers to actively managing their credit holdings. We currently are focused on credit sectors where secondary liquidity remains ample.
What do you see as the biggest opportunities in the Asian fixed-income market?
While market volatility is likely to persist as global economies continue to weaken and liquidity in the bond market remains poor, many Asian credits have more than discounted their expected default risks and present compelling investment value for long-term investors. Asian banksÆ exposures in troubled global credits (example, Lehman Brothers) appear manageable relative to their balance sheet size. We believe that AsiaÆs credit fundamentals, both in the banking and corporate sectors, stand out globally. Our strategic view is that Asian credits should present solid buying opportunities over the coming 12 months and hence will gradually look for opportunities to add fundamentally sound credits with very attractive valuation in our Asian bond portfolios.
The November edition of AsianInvestor magazine contains a feature on the Asian fixed-income market.
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