Arthur Lau, Pinebridge Investments
“The outlook for Asian bonds is strong compared with other regions,” Arthur Lau, the firm’s co-head of emerging markets fixed income and head of Asia ex-Japan fixed income told media in a webinar on Wednesday.
“They have lower volatility and better Sharpe ratios [a measure of risk-adjusted returns] and a major factor is the ‘home-bias’ of many Asian institutional investors,” he said.
In addition, Asian state-owned enterprises, which are substantial bond issuers, typically benefit from government support, especially those sectors considered to have systemic importance to the economy, such as utility providers.
Also, most Asian issuers have the ability to issue bonds in the domestic currency market as an alternative to raising money in the dollar market, and recent local central bank monetary policy easing has lowered their borrowing costs.
Lau’s positive sentiment is shared by many fixed income fund managers who FSA has spoken to in recent weeks, even as markets were in freefall.
These include Aberdeen Standard Investments, HSBC Global Asset Management, Invesco, JP Morgan Asset Management, T Rowe Price and UBS Asset management.
The $147m Pinebridge Asia Pacific Investment Grade Bond Fund, co-managed by Lau and Omar Slim, has posted an 8.87% cumulative return over the past three years, underperfoming its JP Morgan Asia Credit Investment Grade Index benchmark (12.48%), but well ahead of its sector average (2.93%), according to FE Fundinfo data.
The fund’s annualised volatility of 4.61% is higher than its benchmark (3.65%), but less than the average Asia Pacific bond fund (5.07%).
The portfolio is overweight financials and underweight sovereigns to earn a higher composite yield. Its mandated restriction to investment grade bonds excludes most China property issues, which make up around 40% of all Asian corporate bonds.
Its biggest country exposure is China, and the fund is overweight India and underweight South Korea. Holdings include both US dollar-denominated and local currency bonds.
Meanwhile, the macroeconomic environment in the region is improving.
Activity levels in China are picking up and are now close to normal, but GDP growth in 2020 is likely to be no more than 3% to 4%, according to Lau, who also expects exports to recover in the second half of this year.
He pointed out the strong correlation between economic growth in China and other Asian countries due to trade and supply chain linkages.
Moreover, all Asian countries, except Malaysia, are net importers of oil. The supply shock created by the Saudi Arabia-Russia dispute and the fall in demand in the last few weeks which has led to a collapse in the price of oil will mean reduced costs for most of the region. Lower inflationary pressures will allow central banks to cut interest rates further.
Based on historical valuations, Asia bonds also look attractive.
The month-long sell-off in Asia credit markets has presented buying opportunities, although the potential for rising defaults among some sub-investment grade issues means that investors should focus on better quality names, according to Lau.
The widely followed JP Morgan Asia Credit Index (Jaci) has spiked to above 400 basis points (bps) over US Treasury yields, which it last did in 2011 during the European debt crisis.
“Historically, when the Jaci spread reaches about 350 bps, Asia bonds generate mid-teen annualised returns,” said Lau.
The more narrowly-composed Jaci Investment Grade Corporate Index, which tracks the credit spreads of Asian investment grade bonds, widened to 303 bps at the end of March, which is significantly above the 10-year average of 222bps.
“Nevertheless, investors need to be discerning and avoid high yield issuers which have weak balance sheets and need to refinance maturing debt,” Lau warned.
Pinebridge Asia Pacific Investment Grade Bond Fund vs JP Morgan Asia Credit Investment Grade Index and sector average