Morgan Stanley backs China’s onshore bonds

Asset Class in Focus

These assets look attractive for 2019, although Indonesian bonds are the most preferred overall, according to Michael Kushma, CIO for global fixed income.

Michael Kushma, Morgan Stanley Investment Management

Morgan Stanley Investment Management has been avoiding China’s onshore bond market lately due to what Kushma said are complex logistics. But, during a recent media roundtable in Singapore, he said this could change next year.

“The renminbi would then be the first [local currency] market we go to in Asia.”

He said the trigger could be the decision announced earlier this year to include Chinese yuan-denominated securities in the Bloomberg Barclays Global Aggregate Index in 2019.

“We have a lot of business on that index and will have to pay attention to it. We are in the process and we could maybe enter [the Chinese onshore bond market] in Q1 next year,” Kushma added.

Until now, the firm has bought only offshore corporate bonds issued by Chinese companies, “which have struggled a bit this year. Chinese default rates have been rising. [Authorities] have been trying to restrict credit growth and have been liberalising the financial system, letting some companies default.”

But Kushma said he does not expect offshore defaults to spike in the next 12 months.

Even if onshore bond defaults increased, there would not necessarily be an increase in offshore defaults, he added. “China’s international borrowers tend to be larger and more established companies within their sectors.”

Spotlight on Indonesia

In Asia, the firm’s preferred emerging market (EM) for fixed income in 2019 is Indonesia.

Kushma cited the high average yield versus other EMs coupled with a proactive central bank that is making sound decisions.

Indonesian sovereign bonds have a yield range of 5%-8% with a duration of approximately six years, according to Kushma’s data. Corporates are close to 8% with a duration just under five years.

“We currently see value in both Indonesia’s sovereign domestic bond yields and external bond spreads. Our fair value spread models imply a fair value yield for Indonesia local is 7.60% and fair value spread for Indonesia external at 215bp.

“We generally find valuations across sovereign, quasi-sovereign and corporates attractive based on our macro-economic outlook for the country and views on the fundamentals of the individual credits,” he added.

In the corporate bond sphere, the firm has a bias towards the real estate and utility sectors versus corporates in the commodity space, he said.

He added that the Indonesia government has been proactively raising interest rates and protecting sectors amid the US-China trade war.

“It has raised rates continuously, all year long, staying ahead of the curve. It is very focused on the stabilisation of the currency, which suggests that when the external environment improves, countries that have [proactive policies] like Indonesia should be rewarded.”

The firm has a positive outlook on sovereign bond spreads and local rates, which Kushma said he believes will benefit from proactive monetary policy action a strong fiscal position.

“The recent decline in oil prices is also helpful for inflation and current account dynamics. Finally, we believe President Jokowi is likely to win next year’s election, providing continuity to the strong economic policy framework,” Kushma said.


Morgan Stanley EM Fixed Income Opportunities Fund vs the sector, 3-year performance

Source: FE. In USD. The fund is managed by Eric Baurmeister. Note: The fund uses a custom benchmark that combines three indices. It is not available in FE.

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