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Emerging Markets

overview of emerging asia fixed income markets

A class apart: emerging Asia's fixed income market

Fixed Income Monthly
November 2018

Raymond Sagayam, Chief Investment Officer - Fixed income

Why investors seeking a stable and attractive source of return within a diversified bond portfolio should head to emerging Asia.

01

Asian fixed income: introduction

Never waste a good crisis.

If there’s one region in the world that has followed this advice to the letter, it is Asia.

Two decades after the region’s currency crash, Asian economies have thrived, profiting from institutional, regulatory and capital market reforms that have boosted the bloc’s international competitiveness.

Emerging Asia is now the world’s fastest growing region, with its economy expanding at just over 6 per cent per year1. It is thanks to these strong fundamentals that Asian bond markets are becoming deeper and more diverse, and a magnet for a growing number of domestic and international investors.

Boasting attractive yields and low volatility, the region’s bonds deserve to be a strategic holding for those seeking both decent levels of income and diversification.

Overview: rich Asian offering

Investors can choose from four sub asset classes within the Asian bond universe: government bonds denominated in local currency or the US dollar, corporate bonds and Chinese onshore debt denominated in the renminbi (RMB) (see chart).

asian fixed income at a glance
Overview of Asian fixed income markets

* yield to maturity ** S&P ratings
Source: JP Morgan, ChinaBond. Yield, duration and average rating for Chinese local currency bonds are represented by averages for Pictet-Chinese Local Currency Debt portfolio. Data as of 30.06.2018

  • Asian local currency sovereign debt: these instruments are most sensitive to changes in domestic macroeconomic conditions; this market is suited for investors who want to benefit from long-term growth of Asian economies as well as the long-term appreciation potential of Asian currencies. There is also the prospect for local sovereign debt to develop into a defensive asset class over time, as US Treasuries or Japanese Government Bonds have done.
  • Asian USD sovereign debt: this dollar-denominated universe allows investors to profit from strong Asian economic fundamentals but without the currency exposure. Investors in this type of bonds should be able to benefit from the likely improvement in the credit profile of the issuers, which should become the primary source of capital gain in the long term.
  • Asian USD corporate bonds: this asset class is composed of highly rated instruments; nearly 70 per cent of issuers have a rating of BBB and above. That compares with just 54 per cent for the broader emerging debt market. Most issuers are in a stronger position to service and repay their debt than their peers in other regions, thanks to sizeable cash cushions and low debt. The net debt-to-EBITDA ratio of Asian corporations stands at around 1.7 times, compared with 2.1 times for the emerging world and 2.8 times for the US. What is more, Asian credit should develop into an even richer source of investment opportunities as locally-based companies increasingly switch away from short-term bank loans to longer-term debt financing.
  • Chinese onshore debt: Already the world’s third largest bond market, RMB-denominated bonds are growing fast thanks to their attractive yields and because they offer exposure to a currency with potential for strong appreciation. Up until recently, Chinese onshore bonds have been excluded from the flagship EM and global bond indices, but that looks set to change soon. Beijing’s measures to liberalise the capital market should help China’s case for inclusion in major global bond indices, which could generate as much as USD286 billion of fresh inflows into the asset class. What is more, we expect the RMB to evolve into a major international currency over the coming years, which should help attract overseas demand for Chinese assets and boost the value of the currency in the long-run. 

All four instruments tend to enjoy better volatility-adjusted returns than many of their EM (emerging market) and DM (developed market) counterparts (see chart).

Favourable risk return profile
Risk return profile of EM fixed income
All indices are total return and in USD. Source: ChinaBond, JP Morgan, Bloomberg. Based on monthly data from 30.09.2015 - 30.06.2018

02

Strong Asian bid provides anchor

Asian bonds have proven to weather periods of market turbulence better than their emerging counterparts. Chinese RMB-denominated bonds, for example, have outperformed in all of major EM sell-offs in the past decade (see chart).
Asian Resilience

Asset return during major market sell-offs

Asset return during major market sell-offs
Based on the following periods: Global Financial Crisis (01.08.2008 - 31.10.2008) EU sovereign debt crisis (15.08.2011 - 30.11.2011) Taper tantrum (08.05.2013 - 31.12.2013) Turkey-Argentina Crisis (31.07.2018 - 31.08.2018). All indices are total return and in USD. Source: JP Morgan, ChinaBond, Bloomberg
Asian bonds also rarely move in lock-step with mainstream asset classes such as developed market debt and equities and commodities (see chart).
independent mind

Correlation with other asset classes

Correlation with other asset classes
* Both blended benchmarks. 1 = perfect positive correlation, -1 = perfect negative correlation. Source: JP Morgan, ChinaBond, Bloomberg, HSBC. Based on monthly data from 31.10.2008 - 30.06.2018

There are a couple of reasons for this. It is partly because Asia’s bond market is not especially sensitive to commodity prices, which can be extremely volatile.

This is particularly true for Asia’s corporate debt, which has lower exposure to oil, gas, metals and mining industries than the bond markets of other regions2.

Asian bid

More importantly, Asia’s bond market benefits from a large and stable domestic investor base. This group of primarily institutional investors tends to have a longer time horizon and a greater tolerance for currency fluctuations, which helps reduce the overall volatility of the asset class.

In China, foreign investors represent just 2 per cent of the RMB-denominated bond market. What is more, in the Asian credit market, more than 70 per cent of new issues are held by investors based in the region (see chart).

local interest
Proportion of new Asian corporate bond issues allocated, by regions
New corporate bond issues allocation
Source: BondRader, JP Morgan, data as of 31.08.2018

Figures from the Asian Development Bank shows that Asian-based investors have on average had more than 80 per cent of their portfolios in either their home or regional bond markets3.

Separate data shows that intra-regional bond investment rose by nearly nine-fold to USD461 billion in the 15 years to 20164.

This regional bias, sometimes referred to as the “Asian bid”, is expected to strengthen further as central banks in Asia – home to the world’s biggest foreign exchange reserves – seek to recycle trillions of dollars of accumulated savings directly back into the region.

Asian monetary authorities have a keen interest in developing the region’s bond markets to reduce the excessive reliance on short-term bank loans and strengthen the resilience of the financial system through projects such as the Asian Bond Market Initiative5.

All of this should see the Asian bond market develop into a liquid, mainstream asset class that international investors can use to diversify their existing EM or global fixed income portfolios as well as other multi-asset investment.

03

Robust economic fundamentals

Asia’s favourable macroeconomic backdrop is an additional plus. 

under control

Headline CPI inflation, %

EM inflation
Based on a three-month moving average of year on year change in headline CPI inflation. Source: Pictet Asset Management, CEIC, Thomson Reuters Datastream, data as of 11.09.2018

On top of robust growth, emerging Asia enjoys low inflation. Its headline inflation rate stands at 2.4 per cent, a level last seen in 2009. The figure is lower than its Latin American and Eastern European counterparts and below the wider EM reading as a whole (see chart).

Local currency bonds in particular are also poised to benefit from the potential for Asian exchange rates to strengthen in the medium term.

Currency appreciation has been a key source of return in local EM bonds over the past decade, which can account for as much as a quarter of the asset class’s total return6.

 

grab a bargain
EM currencies' deviation from fair value
EM FX deviation from fair value
*Equiponderate exchange rates: CNY, HKD, INR, IDR, KRW, MYR, PHP, SGD, TWD, THB. Data covering period 31.12.1979-28.09.2018. Source: Thomson Reuters Datastream, Pictet Asset Management

According to our economists, Asian currencies are at their cheapest since the 1997-1998 financial crisis, levels that are hard to justify by their robust economic fundamentals (see chart). With the region experiencing rapid productivity gains, there’s plenty of scope for its exchange rates to rise in the coming years.

This is especially the case for the RMB, whose ongoing internationalisation should attract increased investment inflows from overseas. Our economists expect the Chinese unit to rise to RMB6 per dollar in the next five years, with risks skewed towards a bigger move if Chinese economic growth and productivity surprised to the upside (see Secular Outlook 2018, Pictet Asset Management).

04

A rich and diverse investment universe

Asian fixed income markets are rapidly evolving into a strategic asset class for international investors.

Global cross-border bond investment flows show that allocations directed at Asia increased more than five-fold to USD1.6 trillion in the 15 years to 20167.

But the Asian fixed income market may be poised to experience even bigger inflows in the long term. As a growing number of international investors become familiar with the role which Asian bonds could play in a diversified portfolio, their allocation to the asset class – currently far lower than that for other EM regions (see chart) – should pick up over time.

Asia under-represented

Exposure of EM bond portfolios by country

Allocation of international bond investors
Based on JP Morgan Emerging Markets Client Survey, a monthly survey of positioning across EM fixed income and currency assets, covering 200 investors managing over USD1 trillion in EM assets. Scores range from +10 (very overweight) to -10 (very underweight). Source: JP Morgan, data as of 31.08.2018

Case for active investing

We believe investors can capture Asian fixed income’s attractive investment potential more efficiently with an active investing approach.

At Pictet Asset Management, with our long track record in investing in emerging markets, we believe we’re in a strong position to capitalise on the opportunity on offer in Asia’s fixed income market.