State Street Global Advisors (SSgA) highlighted the merits of local Asian bonds at a media roundtable yesterday, and outlined an alternative approach to gain broad-based exposure to the asset class.
Ramon Maronilla, vice-president of SSgA Asia and a member of the firm’s global fixed-income team, underscored the region’s strong economic fundamentals and asset inflows versus developed markets.
He also points to favourable interest-rate differentials, given expectations that policy rates in developed markets will remain anchored at rock-bottom levels for some time, and likely currency appreciation as supporting factors.
“We do expect that asset flows will continue to chase those markets which a) have more robust outlooks for growth; b) deliver higher yields; and c) have exposure to currencies which have positive momentum,” he states.
As a way to gain balanced exposure to Asia’s fixed-income story, he promotes the Iboxx ABF Pan-Asia Bond Index – the region’s first bond-tracking exchange-traded fund – in which the allocation to each constituent market is determined not by market cap weighting but by four combined criteria.
The traditional market-cap approach – the larger the market, the higher its index weighting – has an inherent structural bias to governments that borrow more, he notes, and investors are becoming increasingly sceptical of it given the changing landscape of sovereign risk.
“As a sovereign borrower increases their debt burden by borrowing more, its bond market grows and its allocation in the index grows,” he explains. “This effectively means that investors end up gaining more exposure to borrowers that have just increased their debt levels.”
He favours the Iboxx approach in which market size counts for just 20%; liquidity 20% (as measured in bid-ask spreads and turnover ratios); sovereign debt rating 20%; and market functionality 40% (which measures the degree to which offshore investors can enter and leave a market without impediment).
“The great thing about this index is it not only moves away from the importance of market cap, but it also considers other factors that bond investors really care more about, like the sovereign debt rating, the liquidity or the accessibility to these markets,” he adds.
He presented a slide at the meeting (see graph) comparing a pure market cap weighting for Asian countries against the Iboxx weighting, noting that in the former China and Korea make up 80% of the index.
“It really does not make much sense because a) you want to invest across Asia and have good diversification; and b) offshore investors cannot really invest in China in the first place,” he says.
“However, by looking at the four different criteria [listed above], we believe this has come up with resulting weights that are more balanced and diversified, better reflecting the fundamental characteristics of these markets.”
He suggests that the index was probably ahead of its time, given that it was constructed in 2005; SSgA has been managing a fund since 2005 that closely tracks this index.
“Right now investors are paying more attention not just to local bond markets, but also to this type of methodology that I think is very relevant given the sovereign risks that we are facing at this time,” he concludes.