At a time when diversification matters more than ever, the favourable dynamics of Asia’s local currency bond markets make this asset class an increasingly attractive tool for portfolios.
“For investors worried about the US’ growing debt burden and the uncertainty about tariff policy, local currency government bonds in Asia, where the policy outlook appears clearer, may be a more appealing diversification play than they were at the start of the year,” said Lei Zhu, the head of Asian fixed income at Fidelity International.
In particular, these bonds have low or moderate correlation ratios with major global peers – such as 0.4 with US Treasuries and 0.3 with German government bonds over the past decade.
More appealing than the past
While shifts in global trade are also impacting Asia, there is a strong case to support the region’s local currency bond markets.
Notably, growing economies and increased appetite for domestic debt have added a lot more depth in recent years to the asset class.
For example, the value of outstanding bonds in emerging east Asia increased from $866bn in 2000 to $23.2trn by the end of 2022, according to the Asian Development Bank.
“More index providers have added the region’s local currency bonds to their global indices, enhancing the appeal of the asset class,” explained Zhu. “Ongoing market reforms have led to an increase in foreign participation.”
When considering returns, research by Fidelity shows that if a US dollar-based investor had allocated to nine emerging Asian investment grade sovereign issuers’ local-currency bonds over the 10 years to March 2025 – before the most recent bout of volatility – this hypothetical portfolio would have delivered a 28.2% total return. That compares with 14.5% for a US Treasuries portfolio.
“The Asian portfolio would have exhibited a slightly higher volatility, but its Sharpe ratio outperformed that of the US strategy (0.6 compared with 0.4) as the larger return, largely due to Asian bonds’ higher carry, better compensated for the risk taken,” added Zhu.
Promising outlook
In the near-term, Asian economies look compelling. Inflation is cooling in most of the region, giving policymakers plenty of room to ease.
Already, China, India, the Philippines and Thailand have cut interest rates since ‘Liberation Day’, with other countries flagging the potential for similar moves. “The rate cuts are likely to lead to some capital gains for investors over the short to medium-term, helping mitigate concerns about global trade frictions,” said Zhu.
Over the long term, Asia’s growth outlook looks promising. And Fidelity’s view is that fiscal plans, as well as monetary support, are likely to limit the downward pressure from tariffs on economies.
At the same time, the firm believes, as Asian economies look to domestic demand as a new growth engine, their vast populations and youthful demographics will support the structural shift.
