2018 Best Asia Bond Fund Winner Q&A- Legg Mason Western Asset Asian Opportunities Fund

M: Can you highlight any major changes you made to the portfolio over the course of 2017? Were there any particular holding(s) that drove the fund’s performance for the year?

L: In 2017, the Legg Mason Western Asset Asian Opportunities Fund had significant overweight allocations to Indonesia, India and Chinese Yuan (offshore) bonds. It benefited from the local currency rally, higher carry coupons and bond price appreciation. We also held more investment grade quality quasi-sovereign and corporate bonds, which benefited the Fund as credit spreads compressed. From a risk management perspective, the Fund’s diversified sources of return resulted in a less volatile, better risk adjusted performance.

M: What is your outlook for 2018 specific to the markets you cover, and how are you positioned to take advantage of opportunities and/or mitigate potential risks?

L: The Lunar year of the Dog represents not only duty and loyalty but also defense and protection. Over 2018, Asian currencies may continue to stay firm as global investors lose confidence in both the Trump administration fiscal deficit trajectory and its international policies. Over 2017, currency markets were driven by trade, surpluses and fund flows rather than speculative demand premised on interest rate and growth differentials. Most developed Asian economies have sizable current account surpluses and relatively attractive equity valuations, which are likely to unpin local currency strength this year. Differentiation of emerging markets will also likely be the key performance driver in 2018. Overall, we believe that emerging Asian markets such as India and Indonesia that have modest current account deficits and large accumulated foreign exchange reserves in their respective central banks would be in a strong position to overcome bouts of emerging market outflows that may result from higher US interest rates. Trump’s “America First” insular trade policies will impact small open economies disproportionately while countries with substantial domestic markets such as China, India and Indonesia will be more resilient. Overall, Asia local bonds yielding 260bps* higher than Developed Market bonds (as measured by the JPM GBI-EM Asia versus FTSE WGBI) remain fairly valued, and we believe 2018 will continue to be a strong year for most Asia currencies. 

The Legg Mason Western Asset Asian Opportunities Fund has always included an actively managed allocation to USD denominated bonds issued mostly by Asian investment grade issuers. USD Asian bond holdings have characteristics of better liquidity and stronger credit standing and act as a key diversifier and stabilizer during periods of USD strength (i.e. Asia local currency weakness). From a fundamental perspective, the broad Asian investment-grade corporate credit universe has seen leverage trending down and improvement in liquidity. Furthermore, a significant number of entities issuing USD Asian bonds are government-related entities (GREs), which are likely to receive sovereign support during stress scenarios. On the valuation front, Asian investment grade credit still offers a 60 bps* pickup over Developed Markets investment grade securities, far better than Asian USD high yield, where there is no spread to US high yield.

China is an ever more important anchor for Asia as nationalistic Trump policies and greater volatility return to the markets in 2018. The State Administration of Foreign Exchange (SAFE) and the PBOC are increasingly comfortable with the level of the Renminbi (RMB) and “neutral” capital inflows/outflows. Chinese investors had accumulated large holding of US dollars, which were an important cornerstone demand for USD Asian corporate bonds, half of which are issued by Chinese entities. Given higher Chinese bond yields, foreign inflows into the onshore China bond market (world’s 2nd largest at US$10 trillion) and a soft USD, Asia based investors may opt to invest in Asian local currency bonds instead of USD denominated bonds to match their liability, and possibly protect against suffer from capital losses from rising US Treasury yields.

M: Can you comment on the major risks facing financial markets, such as rising US rates and elevated asset prices? How do these risks affect your investment decisions?

L: Western Asset’s global macro view is that the high debt levels in advanced economies, ageing demographics and the gradual cyclical recovery will constrain the rise in US Treasury bond yields. In addition, low wage growth (the gig economy) and structurally weak inflationary pressures (Amazon effect) across both advanced economies and many emerging markets (EM) should keep major central bank withdrawal of ultra-accommodative policy modest and gradual. In the near term, however, higher than expected headline inflation prints due to the low base effect as well as higher crude oil & commodity prices could alarm bond markets. A more insidious risk could be the US Fed allowing headline inflation to stay symmetrically above their target of 2% although core PCE has remained well below their target since 2012. It is not our base case, but a significant rise in long US Treasury yields could re-price financial assets globally. 

A significant escalation of the “tit for tat” trade tariffs between the US and China may adversely impact Asia risk sentiment. Again, it is key to differentiate and select the larger Asia economies with a large domestic base which will be resilient and avoid high beta, open economies such as South Korea and Singapore. In the medium term, Asia macro fundamentals in terms of FX reserves, external balances, flexible exchange rates and home biased cash rich institutions and individuals can cushion much of the “trade war” impact.

Ironically, the Trump administration policy objectives of deregulation, tax cuts, infrastructure   and bilateral trade deals are clear even though its path and behavior are unpredictable. We are cognizant of the risk that “successful” implementation of Trump economic policies may overheat the US economy, resulting in an accelerated pace of Fed tightening that may result in steep, across the board, rises in US Treasury yields and a stronger USD. This could be a risk-off event that could impact emerging market assets.

As theme of defense and protection is forecasted for the Lunar year of the Dog, it is vital to be thoughtful of risk and headwinds to our preferred scenario, and be selective on country, currency and credits for the Legg Mason Western Asset Asian Opportunities Fund while staying nimble when managing the portfolio.

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?

L: Western Asset’s Asian bond portfolios are managed on a team basis - portfolio managers supported by a cadre of capable sovereign and credit analysts plus other investment professionals. At Western Asset, we pride ourselves on team work within each center of excellence and across all our global offices. The firm is well known for its flat structure, emphasis on mutual respect and a rewarding & collegial working environment that speaks to investment staff retention and continuity.

For the Asia portfolio, the lead portfolio manager for the Fund is Mr. Desmond Soon with 28 years of financial market experience. Desmond works with the Fund’s co-manager Mr. Chia-Liang Lian, who is the head of Emerging Markets Debt to provide the “top down” construct and the Fund strategy. Mr. Swee Ching Lim (Financials, Developers & Conglomerates), Ms. Peng Jie (China SOE & others) and Mr. Wontae Kim (Korea GREs & South Asia) provide the “bottom up” credit research. Together with Mr. Desmond Fu, who is the senior trader and ASEAN sovereign analyst, the team works with portfolio analysts, Ms. Katherine Kuek and Mr. Jing Kai Ng, to continuously evaluate Asia investment opportunities, identify issues and steer the Fund to achieve its investment objective.

Western Asset’s Asian bond portfolio managers are further supported by a global organization with recognized sovereign and credit expertise. The Firm’s team approach unites groups of specialists dedicated to varying market sectors and credits. In addition, Western Asset has an independent dedicated risk management team based in our Pasadena head office and globally that works closely with portfolio managers to calibrate portfolio risk to the client/investor’s requirements.

There have been no changes to the Asia Bond Team or structure in the past year. Depending on demand from clients/prospects, we may add an onshore China investment analyst to the team to tap the huge China bond market.

M: Can you highlight any areas where you feel that the investment team or the investment process can be improved upon?

L: Western Asset has been managing dedicated Asian bond mandates since 1990. Western Asset’s Asian Bond Team’s ability to adapt to a rapidly evolving and challenging investment environment, and navigate the Asia local and hard currency bond markets, has been tested during the crises of 1997 and 2007. The Team’s specialized Asian market expertise arises from in-depth knowledge developed via on-the-ground relationships with regional central banks, government agencies and key market participants such as pension agencies, insurance firms and investment banks. This allows the investment team key insights into market technicals and market participant behavior that cannot be replicated by analysis of quantitative statistics or flow data alone.

In terms of capacity, the Firm has capabilities managing Pan-Asian and single country strategies across Asian Local and USD denominated bonds. The team’s Asian strength comes from the cultural diversity and extensive work experiences that each member brings to the team, with individuals speaking multiple Asian languages including Mandarin and Korean. Such diversity means greater appreciation for the cultural, social and institutional nuances critical to the interpretation of monetary, fiscal and administrative policies in each country and market. Western Asset seeks to develop and leverage this local expertise in navigating Asian bond investments in collaboration with the global macro and credit analysis support provided by investment professionals in our global offices, in particular 28 additional Emerging Market professionals with deep and broad market experience. This philosophy is integrated into a global investment organization spanning five continents and nine offices.

Global financial markets are dynamic and constantly evolving, hence there is no simple elixir for being continuously successful. Instead, we work as a regional and global team to constantly integrate our top down (macro-geo-political) evaluations with our bottom up (company specific) assessments. We believe that this process and synergy will improve the breath, depth and dimension of our portfolio strategy, leading to superior long term, risk adjusted returns for our clients.

View all Morningstar Singapore Fund Awards 2018 articles here.