2019 Best Asia Bond Fund Winner Q&A - NN (L) Asian Debt (Hard Currency) P Cap USD

M: Morningstar N: NN Investment Partners

M: Can you highlight any major changes you made to the portfolio over the course of 2018? Were there any particular holding(s) that drove the fund’s performance for the year?

N: Asian USD bonds faced risk-off pressure in 2018, resulting in wider spreads for the year. Funding conditions for companies were also challenging: weak issuers that were able to come to the market in previous years, thanks to investors’ search for yield, faced liquidity issues in 2018. Several issuers saw their bonds dropping to distressed levels or even defaulted.

Our performance in 2018 was driven by rigorous fundamental credit research. We avoided those distressed and defaulted bonds during the year and held outperforming investment-grade bonds in China and Hong Kong. When valuation levels started to become attractive in the second half of the year, we increased exposure to higher-yielding companies but continued to avoid those with very weak or deteriorating credit profiles.

M: What is your outlook for 2019 specific to the markets you cover, and how are you positioned to take advantage of opportunities and/or mitigate potential risks?

N: Our market outlook is based on our view of three major factors: fundamentals, technicals and valuations. It is rare for all three to be positive at the same time. However, the situation is different for 2019. The sell-off in 2018 has made valuations attractive, with the yield of the Asian debt hard currency market standing at 5.4% at the end of 2018, compared to 4.9% at the start of last year. Already, we have seen a rally of 2.8% in the first two months of 2019 as inflows have returned to the asset class.

The sell-off in 2018 was not a reflection of weakening corporate fundamentals. In fact, companies remain sound: many issuers are still deleveraging on the back of slower capex and more disciplined mergers and acquisitions strategies, while keeping balance sheet strength at healthy levels. Supply dynamics are also expected to improve as we anticipate lower new issuance in 2019. We expect that the strong demand for Asian hard currency assets will continue this year as a result of reduced US-China trade tensions and less hawkish US Fed policy. All three segments – fundamentals, valuations and technicals – are positive for 2019, creating a favourable outlook.

In terms of the fund’s positioning, we entered 2019 with an overweight to large Chinese property developers, particularly the long-end as credit curves remain steep. We also see opportunities in financials, particularly in Korean life insurance insurers via exposure to well-structured perpetual bonds. We have an underweight to sovereigns and quasi-sovereigns as we believe that corporates are more attractive and have more alpha generation opportunities.

M: How have financial market risks, such as the ongoing trade war between the United States and China and tightening monetary policies in major economies, impacted your recent investment decisions? What are some underreported risks that could surface in 2019 or beyond?

N: Our base case is that US and China will shortly reach a trade deal as both countries have stronger incentives to compromise than before. Next year’s presidential elections might push President Trump towards a deal, while China has also made conciliatory gestures, including promising to improve market access for foreign companies.

We think that the central banks in major economies will be accommodative this year and we do not see pressure on Asian central banks to hike policy rates. Inflation is benign in the region and a dovish Fed means there is no pressure on Asian central banks to raise rates.

One under reported risk is the possibility of the US pivoting back to a hawkish stance after taking a pause in its interest rate hiking cycle. Although our base case is that the Fed policy rate is at or very close to its peak, we cannot ignore the fact that the US labour market is very tight and that inflation is close to the Fed’s target. It may not take much for the Fed to become more hawkish if the economic outlook improves. A US-China trade deal would boost global trade and corporate sentiment, potentially causing economic data to surprise on the upside.

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?

N: The Asian fixed income investment team is seamlessly integrated with the global Specialised Fixed Income team, which consists of investment teams covering credit markets in developed and emerging regions. The Asian fixed income team is led by Lead Portfolio Manager Joep Huntjens. Joep is supported by a team of 2 Portfolio Managers, 5 Credit Analysts and 1 Trader, who are all based in Singapore.

The team was enhanced by the addition of one Credit Analyst role last year to match the growth of the Asian fixed income universe. The team is fully staffed and we do not anticipate adding to it in the near future. That being said, the Asian fixed income market is constantly evolving and we remain on the lookout for additional resources if the need arises.

M: Where do you feel that the investment team or the investment process can be improved upon in the future?

N: Given the importance of environment, social and governance (ESG) factors in minimising downside credit risks and adding value to our world, we have developed a sophisticated and consistent structured process of integrating ESG in our investment process. We have always included ESG factors in our security selection process, alongside traditional fundamental factors like financial and business risks, but this old methodology was more qualitative and not mechanised.

Our current ESG process is two pronged: first, we have defined criteria that we believe are relevant to assess the ESG profile of a company. Second, we have identified various external data sources that can help the analyst score each criterion. As ESG integration in investment management is relatively new, we are constantly improving our ESG risk assessment. New data sources to assess ESG risks are increasing on an ongoing basis, and our ESG process is structured in a flexible way to include these new data sources once they become available. Our process has been developed in cooperation with NN IP’s dedicated ESG experts based in our head office in Europe, known as the Responsible Investment team. They also represent NN IP in engaging companies in formal dialogue about responsible behaviour. We believe that as ESG risk data become more sophisticated and transparent, alongside the experience of our analysts, this will increase the quality of our issuer risk assessment.

View all Morningstar Singapore Fund Awards 2019 articles here.