Category Winner: Best Asia Bond Fund - iShares J.P. Morgan USD Asia Credit Bond Index ETF
Key Stats
Inception Date: 2011-05-27
Total Net Assets (Mil) (2017-03-20): USD 38.48
Manager: Not Disclosed
M: Morningstar S: Susan Chan, Managing Director, Head of iShares and Index Investing, Asia Pacific
M: Could you highlight any major changes you made to the portfolio over the course of 2016? Were there any particular holding that drove the fund’s performance for the year?
S: The fund’s investment objective is to track its benchmark, which is the JP Morgan Asia Credit Index Core (“JACI CORE”). The benchmark is designed to be diversified, liquid, and investable, and it’s rebalanced monthly.
Despite global events such as Brexit and US election, Asian Credit market performed well in 2016 with JACI CORE returning 6.25% in the year, driven by carry (income from bond coupons) as well as gains in bond prices due to lower bond yields, as rising US Treasury yields was more than offset by compression in credit spreads. The strong demand for income, coupled with the solid fundamentals of Asian Credit and the technical support for the asset class have all contributed to the strong performance in 2016.
While the fund outperformed the benchmark by 24bps in 2016, the aim is to replicate the performance of the benchmark by using stratified sampling strategy and holding a subset of the index (rather than the full index constituents), seeking an optimal balance between minimizing tracking error and transaction costs, leveraging on the scale and strong execution capability of BlackRock’s trading desk. The 1 year tracking error* was 0.16% and the 3 year tracking error* was 0.18%.
*Tracking error is defined as volatility (annualized standard deviation) of the difference between the fund’s total return and the index’ total return (using monthly data for the past 1 and 3 years).
M: What is your outlook for 2017 specific to the markets you cover, and how are you positioned to take advantage of opportunities and/or mitigate potential risks?
S: We remain constructive on Asian Credit and we expect returns to be primarily driven by carry (income) in 2017. While we acknowledge the potential downside risks on the asset class from higher US Treasury yields, we expect credit spreads to remain stable, with potential room for some spread tightening in 2017. Fundamentals in the region remain strong and the supply/demand dynamic is supportive. Credit metrics remain stable in Asia and expected default risks are low moving into 2017.
The fund’s investment objective remains to track its benchmark, which is the JP Morgan Asia Credit Index Core (“JACI CORE”), by using stratified sampling strategy and holding a subset of the index (rather than the full index constituents), seeking an optimal balance between minimizing tracking error and transaction costs. While the fund does not intend to take active risk, JACI CORE was designed with country diversification rules, which reduced the concentration risk on China and provides investors with a diversified exposure to the Asian credit markets.
M: Can you comment on the macro risks in the global economy, such as the change in leadership in the US, and the significant headwinds faced by emerging markets? How do these risks affect your investment decisions?
S: One of the major risks in 2017 is the direction of US monetary and fiscal policies, and the potential impact to Asia. The expectation of tax cuts and infrastructure spending led to higher inflation expectation and the rise in US Treasury yields. However, the Fed is expected to maintain a gradual path of rate increases, based on the strength of the economy.
While there are certainly macro risks in the global economy, the fundamentals in Asia remain solid and the supply/demand dynamic is also supportive. In addition, the increasing level of ownership of Asian Credit by Asian investors has resulted in lower volatility of the asset class and resilience against external / global events.
Nevertheless, the fund’s investment objective remains to track its benchmark, i.e. the JP Morgan Asia Credit Index Core (“JACI CORE”), providing a broad and diversified exposure to the Asian USD Credit market, through a low cost and transparent vehicle (i.e. ETF).
M: How is your investment team organized? Have there been any changes to the investment team or structure over the past year? Do you anticipate adding to the team in the near future?
S: The fund is managed by the Portfolio Solutions team in Singapore, led by Vish Acharya – Head of Asia ex Japan Portfolio Solutions, and we had a new addition to the team this year.
The Portfolio Solutions team is responsible for managing indexed fixed income portfolios (including ETFs, index mutual funds, and index mandates / separate accounts) as well as implementing ideas and trade sizing across portfolios to ensure scalability and consistency in portfolio construction.
The Portfolio Solutions team in Singapore is part the Asian Fixed Income team led by Neeraj Seth.
M: Can you highlight any areas where you feel that the investment team or the investment process can be improved upon?
S: An index tracking portfolio seeks to replicate the index, rather than outperforming the index through active security selection. Therefore, control of risk relative to the index is key to our investment approach. We would therefore expect to meet our investment objectives to track the benchmark in both up and down markets. We aim to remain fully invested in the market at all times and do not tactically adjust the portfolio using market timing techniques.
We manage indexed fixed income portfolios, including this ETF, using stratified sampling strategy, in order to seek an optimal balance between minimizing tracking error and transaction costs. While stratified sampling allows a degree of tracking error versus the index, it is a more practical solution in replicating bond indices, where an issuer may have multiple issues and some issues can be illiquid and expensive to trade, which are significant constraints for full replication. Hence, stratified sampling can benefit investors with a reduction of transaction costs due to fewer holdings and not searching out illiquid assets, which could be very expensive.
View all Morningstar Singapore Fund Awards 2017 articles here.
