With improving economic conditions in the region, high-quality Asian bonds are expected to attract yield seekers despite the recent global fixed income market volatility.
The hard currency investment grade (IG) segment, which makes up nearly 80% of the market, offers distinct advantages compared to its developed market peers.
As such, Asian IG bonds are expected to perform well due to two key reasons — strong economic fundamentals in Asia and attractive yields of this asset class.
For instance, Asian IG bonds offer higher yield with a shorter duration than US and global IG, where these shorter durations help cushion portfolios in an environment of rising yields.
Investors demanding higher yields could drive interest in Asian fixed income, amidst strong inflows into the market since the start of 2021.
As such, Asian IG bonds remain attractive to global investors in terms of yield, duration, valuation and fundamentals. Economic fundamentals in Asia are stronger compared to other markets across the globe due to better Covid-19 containment efforts, which offer a strong anchor for the region’s recovery.
We can expect a broad economic recovery to take shape this year in countries such as China, Singapore, South Korea and Thailand as accommodative monetary policies remain in place.
In terms of credit metrics, Asia’s corporate net leverage has remained relatively low compared to the US, Latin America, and other emerging markets issuers, while interest coverage ranked highest relative to these three regions.
Moving forward, Asian credit spreads are expected to remain well-anchored, especially given the stable institutional investor base that buffers the market at a time of substantial volatility.
This year, within the Asian IG market, we also expect to see more return dispersion, driven by diverging economic prospects within Asian countries and different outlooks for segments and idiosyncratic issuer risks.
In Singapore, for instance, where the unemployment rate has been declining consistently and the vaccine rollout has proceeded smoothly, we expect a strong, albeit uneven, recovery for the year.
Corporates in the financial and government-related sectors have the most growth potential, while Covid-impacted sectors should be avoided. Non-bank financial institutions also present more interesting valuations and steady fundamentals.
As Chinese corporate bonds remain the largest part of the Asian IG universe, we believe compelling investment opportunities are still present in this space.
Having said that, Asian IG bonds are not without risks and are not immune to the potential impact of macroeconomic factors, where the most dominant theme for the year will remain the pandemic’s impact on economic growth and credit metrics.
While global vaccinations continue to roll out, risks will be contingent on the success and efficacy of Covid-19 containment efforts, including medical breakthroughs and vaccine deployment.
As the Covid-19 recovery broadens across the region, it should be constructive for both sovereigns and corporates, and sovereign credit outlook should remain stable this year.
Default rates in the broader Asian fixed income market should remain benign and the lowest among major regions.
Beyond the pandemic, the evolution of US-China trade relations under the Biden administration will be closely watched, as investors remain particularly cautious on duration risks as the recovery strengthens and US Treasury issuance increases.
At this moment, there is no foreseeable substantial change in the US’s trade policy on China, even with a new administration, and it seems unlikely that there will be a rollback of tariffs that are already imposed, or a scaling back of restrictions on China’s information technology and technology, media, and telecom (TMT) activities.
The future of the “Phase One” deal signed last year remains to be seen. China has fallen behind on its agreed purchases of US exports last year, largely due to the pandemic. While it would seem likely that President Biden may adopt a more multilateral approach in working with allies to formulate a China strategy, it is worth keeping a close eye on US-China trade policy and its potential impact on the fixed income market.
Navigating the trillion-dollar Asian IG market requires solid credit research and selection, issuer differentiation, and agility to reposition portfolios.
There is no substitute for thorough and detailed credit research and selection, and investors should continue to monitor individual issuers’ credit risks as well as ESG factors that could be material to an issuer’s creditworthiness.
When looking at Asian bonds, one should favour greater issuer differentiation to find value opportunities — a downgrade at the sovereign level could still imply opportunities in resilient sectors of that economy.
Active management is key in times of volatility as agility is imperative to reposition portfolios according to market conditions, which cannot be achieved through passive index tracking.
Underpinned by strong and persistent technical factors, as well as resilient fundamentals, the Asian IG continues to be a compelling investment and will retain its status as a stable core fixed-income holding.
In the long run, the ability to navigate Asia’s changing economic, regulatory, and geopolitical landscape will also play a key role in investing successfully in this asset class.
Arthur Lau, CFA, is co-head of emerging markets fixed income, head of Asia ex-Japan fixed income; Omar Slim, CFA, senior portfolio manager, Asia Fixed Income, at PineBridge Investments
