The Asian bond market got off to a roaring start this year, with the second-best performance in more than a decade1 and the imminent groundbreaking inclusion of yuan-denominated bonds in the Bloomberg Barclays Global Aggregate benchmark. But uncertain macroeconomic conditions linger and may bring major headwinds ahead.
Arthur Lau, co-head of emerging markets fixed income and head of Asia ex-Japan fixed income at PineBridge Investments, shares his views on the market’s prospects and how investors can position their portfolios in an ever-shifting environment.
Q. Sentiment for Asian bonds has lifted in the first two months of 2019 from the global sell-off in late 2018. What has changed in the market?
The new year brought more benign trade rhetoric between the US and China, signs of easing in China, and a dovish stance by the US Federal Reserve. That said, economic conditions have yet to show signs of improving, which may affect the fundamental conditions of select sectors.
At the moment, we still expect the onshore credit default rate in China will continue to increase in view of the ongoing deleveraging policy. With somewhat more accommodative financial conditions spurring better sentiment, we think sectors and sovereigns that underperformed last year will benefit this year.
Q. How should investors approach fluid market conditions?
Supply risk and the potential for continued weakening in economic activities may soften overall risk sentiment, and new trade policies can have varying effects on sectors, both positive and negative.
As such, we expect volatility to remain elevated, so investors may need to review their trade positions more proactively and aggressively this year. We think 2019 will require a more tactical allocation in sectors, countries, and names, and a 360-degree view of economic and political developments, along with rigorous credit analysis, will become even more critical.
Q. Why should investors seek an allocation in Asian bonds given this potential volatility?
Asian bonds and emerging market debt in general, are often seen as more volatile than developed market debt. But the Asian bond market is not a high-yield market with high beta and volatility.
Over the past five years, Asian bonds’ Sharpe ratio (i.e., the volatility-adjusted return ratio) has held up very well at 1.51 compared with those of other major asset classes globally (US investment grade credit: 0.87, emerging markets US dollar: 0.88, and US equities: 0.77)2. One reason for this is the strong domestic investor base that understands Asia’s bond market.
Asian bond issuers also tend to have a very low gearing ratio (corporate net leverage) and a high- interest coverage ratio compared with peers in the emerging markets and even some of the developed markets. This is another reason why the Asian market has been able to deliver such a high Sharpe ratio over different business cycles, including some major macro events in the past five years.
Since the 1997 Asian financial crisis, there have been no defaults in the Asian investment grade bond universe.
Aside from high credit quality, high systematic government support for some issuers, especially state-owned enterprises, contributes to the market’s stability. So when market volatility exists, we think the Asian bond market actually becomes more attractive to long-term institutional investors.
Q. The Asian bond market is very diverse across sectors, markets, and credit ratings. Where can investors find value?
The Asian bond market has matured fast since the debt-fuelled Asian financial crisis in 1997, and is gaining greater prominence for global diversification.
We believe investors in this asset class who are selective, are better able to anticipate opportunities and manage risks across different segments of this market.
For example, to illustrate this on a sector level, China’s property sector is typically viewed as high-risk. It experienced funding pressures last year in light of China’s deleveraging.
However, if you are able to dissect the sector, you can identify those stronger and better players that continue to have access to multiple sources of funding, are able to secure their market share, and can gather enough revenues and sales. The same goes for government-related entities, which have different levels of risk. Central government-backed issuers have generally better access to funding than local government-linked issuers do.
In other words, value can be highly dispersed, so security selection becomes much more important.
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1Source: Bloomberg, PineBridge, as of 28 February 2019.
2Source: Bloomberg, rolling five-year data as of 31 December 2018. Asia US dollar bonds by the JPM JACI index; emerging markets (US dollar) by the JPM EMBI Global Diversified index; US investment grade credit by the Bloomberg Barclays US Credit index; and US equities by the S&P 500 index.
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Last Updated 6 March 2017.