Matthew Arnold, State Street Global Advisors
Having grown rapidly over the past decade, the East Asian local currency government bond market presents a significant opportunity for investors today.
The $7.5trn1 capitalisation of the markets that comprise the ABF Pan Asia Bond Index is testament to this. “To put some context around this number, the investable US high yield corporate bond universe totals about $1.5trn,2” Arnold said.
Further, East Asian local currency government bonds offer the prospect of higher yields and exposure to the favourable growth characteristics of the region.
Buoyant demand
Demand has come within the broader context of the growing appetite for Asian local currency bonds.
Although equity markets were incredibly strong in 2017, with State Street seeing investors large and small allocating to equity funds and ETFs, this was not at the expense of fixed income. There was significant buying of bond ETFs – especially if they provided exposure to emerging markets.
“One of the key drivers last year was investors getting more comfortable with the ETF structure as a means of investing in bonds,” Arnold said.
With yields remaining low in much of the world, investors have been increasingly focused on reducing their costs and getting value for money. “Fixed income ETFs are also very easy to use and enable investors to buy a portfolio of bonds in a single trade using the same infrastructure as listed equity trades,” he added.
When it comes to Asian local currency bonds in particular, most of the demand came from broad global emerging market bond funds and mandates. Notably, Asia outshone its two main competitors for local currency bond appetite – Latin America and Europe.
“Investors appeared to favour the superior growth and structural changes we see in the region today,” Arnold explained.
Portfolio diversifier
Part of the appeal is also the fact that Asian local currency bonds offer benefits such as diversification to typical multi-asset investors.
“If you look at a global multi-asset portfolio that invests in developed market equities, bonds and real estate, for instance, Asian local currency bonds should be something of a diversifier with unique risk and return characteristics,” Arnold said.
From a fundamental perspective, meanwhile, the region is generally experiencing strong economic growth. This has made the fiscal characteristics of the countries that make up the ABF Pan Asia Bond Index the envy of much of the developed world, he said.
“While the US Federal Reserve has started to raise interest rates, they remain at rock-bottom levels throughout much of the world,” Arnold added. “The yield pick-up offered by Asian local currency bonds should be desirable for investors worldwide.”
Currency considerations
Another key factor when investing in Asian local currency bonds relates to currency movements.
However, forecasting currencies is a notoriously difficult proposition. The assortment of “unconventional” monetary policies employed by central banks around the world has made it even more difficult. Plus, relative currency performance is driven by dynamics that range from technical to fundamental and usually include variables such as relative economic growth, inflation and interest rate expectations.
“If one were to generalise, you could say that over the long term, currencies tend to do well where the local economy is growing and monetary policies are sound and focused on maintaining price stability,” said Arnold.
This is important for international investors in Asian local currency government bonds because over time, much of their total returns will be driven by the performance of the basket currencies relative to their home currency. “This means that investors should hold a generally positive view on the prospects for Asian currencies relative to their own,” he added.
Invest in Asian local currency bonds with ABF Pan Asia Bond Index Fund. Visit www.abf-paif.com to learn more.
¹Source: Amount outstanding in USD, Asia Bond Monitor (November 2017), Asian Development Bank as of 30 September 2017.
²Source: Bloomberg, total amount outstanding of the Bloomberg Barclays US Corporate High Yield Bond index is $1.34trn as of 31 December 2017.
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