Esther Koon, senior fixed income portfolio manager at State Street Global Advisors, shares her insights on the year ahead for the Asian local currency bond market with AsianInvestor.
Q. How confident are you that Asian local currency bonds will continue to perform well heading into the second half of 2018?
Asian local currency bonds, as measured by the Markit iBoxx ABF Pan-Asia Index which invests in the government bonds of eight major Asian economies, achieved a total return of close to 10% last year. In 2018, this positive trend is likely to continue though to a lesser extent as I expect smaller gains in Asian currencies against the US dollar. Asian local currency bond returns tend to be driven by Asian currency performance and against a backdrop of rising US interest rates, the rate of Asian currency appreciation is expected to be modest as the US dollar is likely to be stronger this year compared to 2017. While economic growth of Asian economies has been robust, inflation has so far remained subdued, hence the pace of monetary policy tightening, if any, is likely to be gradual.
Senior fixed income
portfolio manager at
State Street Global Advisors
Q. Why are Asian local currency bonds attractive to global investors?
The attractiveness of Asian local currency bonds is due to several factors including improved fundamentals resulting from strengthening economic growth, low inflation and healthy fiscal balances.
These positive fundamentals are well recognised by the markets, as evident in the rating agency Moody’s recent upgrade of Indonesia’s sovereign rating by one notch to Baa2 (April 2018) and Fitch’s upgrade of the Philippines’ rating by one notch to BBB (December 2017).
Other factors include relatively higher yields compared to the developed bond markets, good diversification benefits given the low correlation of Asian local currency bonds with other developed bond markets, and attractive returns with moderate volatility.
Asian local currency bonds markets have expanded significantly in past years from a market cap of US$304 bilion in 1998 to over US$12 trillion as of December 2017, representing close to 4,000% of growth in market size in just 20 years. With the markets continuing to grow and hence the widened opportunity set, as well as the diversification benefits that the asset class can bring to multi-asset portfolios, we expect Asian local currency bonds will be increasingly used by both Asian and global investors as a strategic asset in their portfolios over the long term.
Q. What could affect Asian local currency bonds performance in the medium term?
Investors’ sentiment towards the Asian currency and fixed income market is a key factor affecting bond performance, especially with Indonesian and Malaysian bonds where foreign ownership is high. When foreign ownership is high, bond markets in Indonesia and Malaysia are more vulnerable to capital outflows by foreign investors. Capital outflows could happen if a faster-than-anticipated rise in US bond yields starts to trigger a repricing of Asian assets, and so adversely impacts bond performance.
Given growth in most Asian economies is still largely driven by exports, another risk is the growing threat of US trade protectionism. Trade tensions between US and China continue and it remains to be seen whether a trade war could be totally averted.
Other major developments such as the inclusion of Chinese and Indonesian bonds into the global bond indices would help improve the overall sentiment towards Asian local currency bonds and would have a positive impact on performance.
Q. Which local markets in Asia will be the best or worst performers in 2018?
Thai bonds are likely to outperform other Asian local currency bonds on the back of strong currency appreciation and benign inflation, particularly since Thailand is not expected to hike rates against such a helpful inflationary backdrop. On the downside, Philippines bonds are expected to have the worst performance, given the peso is the worst performing Asian currency, amid concerns about that nation’s rising trade deficit and higher-than-expected inflation. With headline inflation continuing to stay elevated, the central bank is expected to hike rates this year and this would drive bond yields higher.
Q. Do global investors need to be cautious about factors such as elections and geopolitical risk in the year ahead?
Malaysia’s watershed election result was a surprise to the market and investors are now increasingly concerned over Malaysia’s fiscal deficit position with the higher than expected public debt coupled with the abolishment of the goods and services tax (GST). Indonesia will hold its regional elections in June this year, and its presidential elections in April 2019. Given President Joko Widodo’s popularity and high approval rating, its elections are likely to have minimal market impact. Geopolitical tensions in the Korean peninsula remained a risk with the uncertainties around the landmark meeting between the US and North Korea. Although political uncertainty remains in Thailand, as a result of the military government pushing back the date for a general election, I believe this should not affect market sentiment, for now.
Invest in Asian local currency bonds with ABF Pan Asia Bond Index Fund. Visit www.abf-paif.com to learn more.
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