Manu George, Schroder Investment Management
“Given that Asia and US dollar [investment grade corporate bonds] have the same average credit rating, these discrepancies in yield, spread and interest rate risk would appear to reflect a degree of mispricing in the market,” said Manu George, senior investment director, Asian fixed income at Schroders.
He points out that Asian investment grade (IG) corporate bonds in aggregate offer better credit spreads than either US IG or euro IG.
Higher absolute yields and spreads versus US Treasuries have encouraged buyers this month, rallying Asia bond prices and prompting a strong start to the year for the sector.
In fact, all of the 300-plus Asia fixed income funds monitored by FE are in positive territory so far. They are led by products from Blackrock, Allianz and Fidelity funds with minimum returns of 5%.
At the end of the 31 December 2018, the yield spread on the Asia IG Index was 183 basis points (bps) above the US Treasury yield, with duration of 4.8 years. This compared to a spread of 159bps and duration of 6.9 years for the US IG market.
These price discrepancies are also pronounced in the high yield (HY) market where Asia yields over 10% (US dollar terms), a spread of 759bps, while US dollar HY, which has the same average credit rating, yields 7.9% for a spread of 533bps.
By the same measures, Asian HY is also more attractively valued than emerging market HY, which yields 8.1%, with a spread of 546bps and 2.1 years duration, though with a similar composite credit rating.
The key headline risks for Asia are signs of further slowdown in China and potential for an escalation of trade tensions between China and the US.
“A concern is Chinese property, which is a substantial component [about half] of the Asian corporate bond market, particularly in high yield, and contains some of the most conspicuously low valuations,” said George.
“Default rates in Asia have increased slightly, from a low level, and remain below the global average,” he added.
“Although we expect a moderate increase in 2019, it is not enough to justify the current valuation levels.”
Schroder ISF Asian Bond Total Return Fund vs Sector
Source: FE Analytics. Three-year cumulative return in US dollars. The fund’s benchmark, the JP Morgan Asia Credit Index, is not in the FE database.