Why Asia bonds remain resilient in a rising-rate environment
As rising inflation, rates and geopolitical risks cast a shadow over global fixed income markets, Asia corporate credit spreads have widened in tandem with the global risk-off sentiment, but are still in line with other markets.
However, Asia bonds - both the IG and HY segments - have a differentiated risk profile compared with their peers, offering a relatively stable and attractive source of yield and diversification for investors at a time of great uncertainty.
Attractive yields with shorter duration
In this rising rate environment, Asia bonds offer the advantage of having shorter duration than their US and global aggregate peers, both in the IG and HY segments. For example, Asia IG has approximately three years shorter duration than US IG, but offers higher yield. Similarly, a comparison of US HY and Asia HY highlights the latter’s shorter duration, but with nearly double the yield.
This higher yield, shorter duration combination helps portfolios absorb the impact of interest rate changes. Active duration management at the portfolio and security level should minimise the risk of erosion in bond values and potentially enhance returns.
Advantage Asia: shorter duration with better yield
Source: Bloomberg, PineBridge Investments as of 31 March 2022. For illustrative purposes only. We are not soliciting nor recommending any action based on this material.
Low correlation to US treasuries
Over the medium to long term, we believe the rising rate cycle will have a moderate impact on Asia credit. Over the past 10 years, the sensitivity of Asia IG bonds to interest rates stood at 0.5 R2, which indicates moderate correlation.
Within the Asia HY segment, the sensitivity is negligible at 0.0003. This suggests that holding Asia bonds should be more favourable than US bonds, particularly at the beginning a rate hike cycle.
Historical correlations between Asia bonds and US treasuries
Source: PineBridge Investments, as of 4 April 2022. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
Credit spreads for the HY sector continue to trade at historically wide levels due to ongoing concerns within the China property space. But with ultra-low correlation to US treasuries, the wider credit spreads within the segment should provide a buffer to offset the rise in interest rates.
Stable credit fundamentals
Key credit metrics for Asia corporates are steady or improving, and fundamentals are expected to remain strong as South-east Asia and South Korea emerge from Covid. We believe this environment will support a spread tightening bias against US bonds.
Asia corporate credit metrics remain healthy
Source: Bloomberg, J.P. Morgan as of 31 January 2022. For illustrative purposes only. We are not soliciting nor recommending any action based on this material.
Although China is a major component of the Asia bond universe, the market offers a diversity of issuers with different credit profiles and from different markets. The US dollar-denominated Asia IG market has grown to nearly $1 trillion1 in market capitalisation and encompasses high-quality issuers from emerging markets such as Indonesia and the Philippines, as well as developed economies like Singapore, Hong Kong and South Korea.
The significant presence of quasi-sovereigns is a key characteristic of the Asia IG market unlike its global peers. Asia IG fallen angel risk also remains low compared with peers and potential credit events are isolated to certain sovereigns and Covid-impacted sectors such as gaming.
Similarly, Asia HY has also gone through some rapid expansion in recent years; although recent negative headlines, particularly from the Chinese property sector, have put pressure on the market and its market cap has declined in recent quarters.
That said, we believe the sector has been oversold recently and higher quality issuers with stable fundamentals and no financing pressures offer attractive risk/return profiles.
While risks to Chinese growth have increased in recent months, policy easing is now expected to ramp up more aggressively over the remainder of the year. This backdrop has created greater pricing dispersion and unveiled opportunities in our view, particularly in higher quality names which we believe will be greater beneficiaries of this policy shift.
The HY market is also sufficiently diversified, offering credit selectors variety beyond large Chinese property issuers.
Limited impact from geopolitical concerns
Amid the market volatility set off by the Russia-Ukraine conflict, we do not expect a direct impact on Asian economies and Asia bonds given trade between the two countries and Asia is relatively small.
However, the Asia fixed income market may see short-term risk aversion and fund outflows. In our view, Asia IG and non-China HY bonds will remain resilient and face no liquidity issue. Select commodities and energy-related assets could see enhanced demand due to supply disruption, and this could be favourable for some industries in Asia.
For example, high coal prices could benefit Indonesia’s coal sector. Meanwhile, markets like India, which is a net oil-importing economy, may see a bigger impact on its public finance and economic activities from the surge in oil prices. We will continue to actively monitor the continuing impact of commodity prices at the sovereign and corporate credit levels.
Given the prevailing uncertainty, we believe it is time investors consider allocations beyond global benchmarks. With flexibility and discipline, active management should allow investors to expand into new markets and uncover exploitable gaps between fundamentals and prices in overlooked segments, while potentially protecting portfolios from volatility.
With highly competitive yield, low rate sensitivity and strong fundamentals, a highly select portfolio of Asia bonds should offer investors a robust solution for the challenges at hand.
For more on PineBridge Investments’ Asia bond solutions, please visit www.pinebridge.com.
1 - Source: J.P. Morgan as of 25 February 2022
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