Fund selectors in Hong Kong, Singapore and Bangkok told FSA in a survey conducted in June that they planned to increase their asset allocation to local currency Asian bonds in the next 12 months. This sentiment represents a reversal from March, when FSA conducted an identical survey and more respondents said they would reduce their exposure.
Intentions for asset allocation to local currency Asian debt in the next 12 months
Data: FSA Asset Class Research
Claudia Calich, fund manager of M&G Emerging Markets Bond Strategy offered insight into the surprising reversal.
The shift in the sentiment should be viewed in the broader context of the US dollar and the recovery of other currencies, she told FSA.
After peaking in December 2016, the US dollar index, which measures the dollar’s strength relative to a basket of other currencies, stayed flat until late March, then started declining in the second quarter. The reason for the decline is “a combination of temporary expectations on how quickly the Fed is going to be hiking rates and reducing the stimulus to the balance sheet,” Calich said.
“There’s also been a small downward revision on the strength of the US economy next year.”
The change in market views on the US came with the realisation, in the second quarter, that much of the Trump administration’s agenda around tax cuts and infrastructure spending has stalled. “The market was way too optimistic about the strength of the US economy,” Calich said.
Because of a gradual rally in US Treasuries, expectations that the Fed will increase interest rates have decreased. Thus, the case for the US dollar outperforming other global currencies grew weaker.
In Asia, in the meantime, economic data from China has been calm and the fear of an domestic economic slowdown has abated, at least for the remainder of this year, Calich noted.
“The market got much more comfortable with China’s capital account,” she said, despite the country’s efforts to stem capital outflows. “This bodes well not only for the renminbi, but for broader perception of other Asian currencies.”
Calich’s portfolio does not currently have exposure to China. “We are underweight but that doesn’t mean we are not interested,” she said.
The main obstacle is access. M&G has established the ability to trade Chinese bonds through the Qualified Foreign Institutional Investor (QFII) scheme. Calich has not used it in management of her portfolio, however, mostly due to operational issues which she felt limited the flexibility of making investment decisions, but also due to the limits on the ability to repatriate the money to meet fund liquidity requirements.
Calich is looking forward to utilising the Bond Connect, the recently launched channel allowing foreign institutions a more direct access to China’s onshore bond market.
“The consensus view is that [China’s] currency is going to remain relatively stable until the end of the year, with the party congress [to be held in the autumn],” she said. “Chinese yields are definitely much higher not only than what they were a year or two ago, but also compared to other lower-yielding currencies in Asia.”
EM currency appeal
Although still under-invested in Asia compared to other emerging markets such as Latin America and Eastern Europe, Calich has been increasing her allocation to Asian debt. M&G’s Asia local currency exposure in the emerging markets bond portfolio has increased to 10.71% in June from 6.15% in March.
“Emerging market currencies are a better investment proposition now versus what they were one or two years ago,” she said. She added that her largest currency exposure in the region was to the Indian rupee.
Calich’s Southeast Asia investment includes bonds from Singapore, Indonesia, Thailand and Philippines, but she stays away from Malaysia. She said she had not been comfortable with the country’s level of debt and contingent liabilities.
“A lot of budget activities and spending is not captured in the data,” she said.
She believes the global credit rating agencies were too generous to Malaysia with their A-level credit rating.
“It is a very heavily-levered economy through public and private sectors and individual consumers,” she noted. “I’ve always been avoiding it on fundamental grounds.”