As Asian bond markets experience a number of headwinds from rising US rates, depreciating local currencies to deteriorating credit quality, our Asian fixed-income panellists at the second Morningstar Institutional Conference in Hong Kong discussed the effects that these cyclical headwinds had on Asian bonds and outlined the investment opportunities that they have identified in this evolving market.
Stephen Chang, head of Asian fixed income at JPMorgan, Rajeev De Mello, head of Asian fixed income at Schroders, and Vivek Ahuja, portfolio manager at Franklin Templeton, shared their thoughts on Asian bond markets. Chang manages the JPMorgan Asian Total Return Bond Fund, which has a Morningstar Analyst Rating of Bronze, while De Mello manages two Neutral-rated funds including the Schroder Asian Bond Absolute Return Fund and the Schroder Asian Local Currency Bond Fund. Last but not least, Ahuja is an integral member of Franklin Templeton’s Fixed Income Group, which manages the Templeton Asian Bond Fund.
Market Outlook
The session began with a live poll that indicated the majority of the audience was either looking to maintain or reduce Asian fixed-income allocations. De Mello was not surprised by the poll results, but, rather, he sympathised with investors’ cautiousness towards the asset class, taking into consideration the uncertainties surrounding global markets and their anxiety towards the fed’s expected rate hike in the second half of 2015.
Chang advocated for a total return, unconstrained strategy as he believed the use of hedging tools can help reduce interest-rate sensitivities and provide scope to be more selective in a rising-rate environment. This would in turn allow him to take advantage of selected opportunities without adding meaningful interest-rate exposure. Although Chang has been more defensive in the asset class over the short term, he remained reasonably optimistic as the demand for bonds remains strong, especially amongst institutional investors who look to diversify from their developed-markets fixed-income exposure.
Ahuja shared his views from a local-currency perspective and outlined how the impact of the US rate hike needs to be considered in conjunction with the amount of liquidity that the European and Japanese central banks are creating within the G3. He said that most of the liquidity created by the Bank of Japan is expected to flow into Asia. Furthermore, Ahuja sees Asian economies as beneficiaries of a lower oil price, given that most of them are price-takers in the commodity. And despite the potential for some market volatility when the US raise rates, Ahuja believes that the spreads offered by the short end of the curve in local-currency markets remain attractive, as Asian economies have collectively run current account surpluses and have accumulated significant foreign reserves over the years.
Duration
On the question of duration, De Mello had a bifurcated positioning in his portfolios. On one hand, he maintained overweightings in selected Asian markets where rate cuts are expected, namely China, India, and Indonesia. At the same time, he held underweightings or even outright short positions in markets that are closely tied to the US, given the view that US rates are expected to grind higher.
When compared with the funds managed by De Mello and Ahuja, the JPMorgan Asian Total Return Bond Fund had a considerably longer duration position, but Chang stressed that, at four years, the fund still has an underweighting relative to many benchmark indexes. Given the steepness of the US yield curve, he believes that the fund needed to move out further to earn a higher yield and the high demand for bonds provided support for prices, as the rise in Treasury yields was largely offset by a tightening of credit spreads.
Currency
The discussion then shifted from duration to currency. In a similar fashion to last year, the audience was asked to pick a major currency that would deliver the best performance in the coming year. This year, with the expectation that US interest rates will move up for the first time in nearly a decade, an increased majority (58.1%) opted for the US dollars. With the JPM fund having an 80% exposure to the US (or Hong Kong) dollars, the view is certainly shared by Chang, who believed that the US dollar is on a strong trajectory over the medium term, largely on the back of robust US growth and normalising rates.
De Mello also had a bias towards the US dollar, but, at the same time, he maintained some exposure to the renminbi and Indian rupee. For the renminbi, De Mello believed that it is “worth the carry” given that China’s stimulus would come in the form of lower interest rates. Similarly, the Indian rupee also offers attractive carry despite the scope for a modest depreciation, as De Mello was confident that the institutionalisation of the Reserve Bank of India can bring down longer-term inflation.
Although Ahuja acknowledged that the US dollar would strengthen against the euro and Japanese yen, which explains his short position on the latter, he is more sanguine on Asian local currencies and held diversified positions across the Malaysian ringgit, the Indian rupee, the Philippines peso, and the Korean won. Ahuja further explained that his positive view was supported by the strength of Asian economic fundamentals, from capital account and fiscal surpluses in Korea to good policy actions in Malaysia and the Philippines.
Credit
The conversation then moved to the credit space and the opportunities that the panellists find within it. Chang believed that the best opportunities were in investment-grade credit, as the improvement in credit metrics placed it in a more favourable position to high yield, where fundamentals have deteriorated after a relatively benign environment in earlier years.
For De Mello, the maturity of the credit cycle has led him to gradually reduce his allocation to credit, but he continued to see bottom-up opportunities when taking into consideration the structural development of Asian credit markets over the past decade. From a sector perspective, De Mello sees opportunities in Chinese industrials and state-owned enterprises (SOEs), and the latter was echoed by Chang, given the pricing inefficiencies of certain middle-tier SOEs.
Structural Opportunities
The session ended with a discussion on structural opportunities. Chang believed that the Chinese bond market offers immense structural opportunities for investors as China continues to open up and liberalise its financial markets. The view is shared by De Mello, who sees considerable opportunities in the onshore bond market as the pace of reform accelerates in China.
Despite the cyclical headwinds, the panellists provided valuable insights that not only showed opportunities but also a promising future for Asian fixed-income investors as the asset class continues to develop and evolve. The informative session gave the audience an understanding on how leading Asian fixed-income investors are thinking today.
