Hunger grows for Asian fixed-income

May 21, 2018 09:30
From an investment perspective, most Asian currencies appear undervalued against their true potential – and especially undervalued against the US dollar. Photo: Bloomberg

The financial crisis that affected Asia in the 1990s scarred both the region and its governments, prompting politicians and policymakers to learn from their mistakes. With structural reforms, tighter regulations and improved capital requirements, their efforts have paid off, and it is becoming abundantly clear that Asia's economy looks very different than it did just 20 years ago.

• Investment in research and development is being done at a strategic level between governments and corporations.
• Asian nations are striving to improve their competitiveness and optimize an increasingly well-educated labor force.
• Governments are focused on building sustainable structural growth by improving household incomes and encouraging economic “rebalancing” – redirecting consumption towards discretionary spending.
• Led by China’s "One Belt, One Road" program, Asian nations are aiming to boost intra-regional development and trade – working collaboratively at a time when the US is becoming more self-centered.
• Institutional frameworks of laws, regulations and procedures have been tightened, and Asian currencies are now free-floating in the markets with little intervention.

If these efforts are successful, Asia should be able to rely less on the US economy and the US dollar over time – a marked turnaround from the run-up to the Asian financial crisis during the 1990s. This is having a profoundly positive impact on the outlook for Asian fixed-income.

A bright future for Asian fixed-income

Asian debt markets have grown bigger and deeper, totaling around 1 trillion in US dollars and around US$13 trillion in local currencies – clearly avoiding an overreliance on the US dollar. Growth in these markets is being fuelled by Asia’s savers putting their money to work in Asia, not exporting it to the US to finance excessive US consumption.

From an investment perspective, most Asian currencies appear undervalued against their true potential – and especially undervalued against the US dollar, which we expect to see weaken over the next few years. We believe this will prompt more investors to pursue undervalued opportunities in regions with better fiscal fundamentals – a felicitous confluence of events for Asian bonds.

With a growing emphasis on individual responsibility for pensions, education and healthcare, Asia is likely to see growing demand for all types of financial assets – and fixed-income securities top the list. Risk-averse Asian investors may be particularly attracted to the good credit ratings and strong financials of many Asian sovereign bonds.

Multiple factors point to positive drivers of future returns.

For global bond portfolios, Asian bonds can be a crucial ingredient. They have the potential not only to enhance returns in US dollars and local currencies, but to help reduce portfolio risk. To that end, we expect the drivers of future returns to be positive, founded on a host of encouraging factors:
• Currency strength throughout the region
• Safe and credible sovereign ratings and finances
• Attractive yields, particularly within the global context of financial repression
• Solid economic regional growth, which may lead to lower corporate-default levels
• The growing maturity of corporate and individual investors as savings markets deepen and economies continue to prosper

Ample scope for long-term growth

With the painful lessons of the 1990s learned, and with solid reforms in place, Asia offers exciting economic growth and investment potential without the distorted monetary policies in effect across much of the developed world. Thanks to China’s rebalancing efforts and its opening-up of currency, bond and equity markets, we expect to see new investment opportunities present themselves to regional and global investors over time. Economies across Asia should be able to generate good corporate prospects, enabling an ever-improving corporate bond market and creating a strong tax feedback loop that could allow governments to fund new investments and create even more attractive long-term opportunities.

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As Global Strategist at Allianz Global Investors, Neil Dwane is responsible for presenting strategic house views and overseeing the Economics and Strategy Research teams.