Asian bonds are rising in popularity. Vibrant economic growth, coupled with competitive yields and increased credit issuance across the Asian region, has garnered robust investor interest. Investment approaches to Asia’s bond markets, however, are not all equal.
A blended approach to Asian bonds could be the best route to sustainable income for investors as it invests in both Asian local currency and Asian dollar bonds (USD-denominated bonds from Asian issuers) to exploit opportunities across interest rates, credit, and currencies.
The blended approach presents an expansive investment universe of Asian government and government-related bonds, as well as corporate bonds issued by fast-growing and blue-chip Asian corporations across many sectors. It also helps us to effectively identify the best opportunities across both local and USD-denominated markets while prudently managing downside risk.
Diversification of risks
Besides an expanded opportunity set, another benefit of adopting a blended approach is improved diversification. Portfolio theory states that a combination of investments that are not perfectly correlated, in this case local Asian bonds and Asian dollar bonds, can lead to lower risk.
The application to a blended portfolio of Asian bonds can be illustrated through an example. If we look at the returns and volatility over the past 10 years for Asian dollar bonds and Asian local currency bonds, a hypothetical blended portfolio (50 percent Asian dollar bonds and 50 percent Asian local currency bonds) would have achieved lower overall portfolio risk than portfolios invested in 100 percent of either Asian local currency bonds or Asian dollar bonds.
The three main strategies or performance drivers within the blended investment approach can be categorized by interest rates, credit, and currency.
• Interest rates: This could involve selecting bonds that offer higher coupons for income or selecting bonds where interest rates are declining, which can result in capital gains. The blended approach ensures there are views on local interest rates across the key Asian local bond markets.
• Credit: This refers to holding corporate bonds in the portfolio. Typically, returns are generated if credit spreads tighten, reflecting improving fundamentals for a company, or if the macroeconomic environment has improved and there are more flows into the asset class. While we can and do participate in Asian corporate bonds denominated in local Asian currencies, the Asian credit market is dominated by USD-denominated bonds.
• Currency: With the blended investment approach, the investment team may choose to take risk-controlled views on the trend for Asian currencies versus the US dollar, or trends within individual Asian currency pairs to contribute to total returns.
Although certain strategies will perform better under different market conditions, the blended approach to Asian bonds ensures the portfolio is well diversified in terms of exposure to the three underlying strategies described above.
Most value expected in interest rates followed by credit and currencies
Central bank policies will be in the spotlight over the second half. In the United States, we think the Federal Reserve will continue to gradually normalize monetary policy and begin unwinding its balance sheet on the back of economic strength, buoyed by strong employment numbers and solid company earnings.
With stronger growth and lower political risk in Europe, the European Central Bank may also look to begin tapering of its quantitative easing. These potential moves by major central banks will be closely watched by the market along with the potential to cause volatility.
In Asia, we expect the strong first-half growth experienced in China will allow the People’s Bank of China to continue deleveraging efforts. While Asian economies have benefited from the recent uptick in global demand, domestic conditions remain challenging and Asian central banks retain a bias to accommodative monetary policy. Given this backdrop, we see better value in interest rates, followed by credit and then currencies.
Overall, we remain prudently positioned given uncertainties to the global environment but expect the Asian bond asset class to be well supported and on track to continue delivering attractive income and returns for investors.
Furthermore, we believe a blended and dynamic approach to Asian bond investing is well-suited to both the current environment and in the year ahead, given that macroeconomic uncertainty is set to persist.
– Contact us at [email protected]