Government bonds have long been considered a core component of many investment portfolios, including for pension schemes, where participants are often advised to lift fixed income allocations as they near retirement. In June 2021, the OECD noted that half of global retirement assets — which had grown by nearly one-tenth to over $35tn in the year to December 2020 — were invested in bonds. Bond holdings are also considerable in insurance portfolios.
Foreign interest in Asian bonds, however, has been modest, with overseas holders' involvement only picking up from 2008. Historically, low weightings in Asian fixed income might have made sense. Opportunity was limited and came with risks. The Asian financial crisis in the late 1990s was exacerbated by excessive short-term overseas borrowing in non-local currencies, primarily the US dollar.
The situation has changed on both fronts, with expansion in Asia's local currency bond markets since early 2000 presenting a new pool of investible assets. "The market size of aggregated local currency government bonds and corporate bonds in ASEAN plus China and Korea is almost equivalent to US treasuries — a really large market — and the euro area's euro-denominated bonds,” says Satoru Yamadera, advisor for the Asian Development Bank’s Economic Research and Regional Cooperation Department.
As the market has expanded, liquidity has also improved. Bid-ask trading spreads have compressed from 15 basis points to under one basis point in China1 since 2008, with similar contractions in other markets across the region. Access has been enhanced by initiatives such as China's Bond Connect, which since July 2017 has allowed foreigners to buy renminbi-denominated bonds in what has become Asia's largest bond market.
The risks, too, are not what they once were, with marked improvements in Asia's fiscal backdrop since the Asian financial crisis. "At the time, policymakers in east Asia noticed that heavy dependence on US dollar short-term finance is the source of vulnerability", driving a deliberate shift towards longer term local currency financing, says Yamadera. "They have really learned the lesson from the Asian financial crisis."
Thailand, for instance, has reduced its dependence on overseas debt. In the decade prior to the pandemic its government local currency debt-GDP ratio rose just one-tenth, from 30 to 34 per cent.2 Meanwhile, McKinsey notes that Indonesia's "sound fiscal discipline" prior to the pandemic has given it more leeway to issue debt to shore up its economy. Across the region, robust debt issuance has been supported by healthy economic growth. Meanwhile, a large proportion of this debt is held by domestic institutional investors — a steadier holding base that reduces the threat of capital flight overseas.
Global systemic risk is also less of a worry. Even before Covid-induced reshoring, McKinsey observed that gross cross-border flows globally were down by half in absolute terms since 2007, significantly reducing the likelihood of a 2008-style financial crisis. This disentanglement not only reduces financial contagion risk, it suggests that if one region is struggling, others can still thrive, further favouring geographical diversification.
“We have seen increased demand for Asia’s fixed income market as it offers higher yields and diversification benefits with its low correlation with other major assets. Growing appetite for Chinese assets and their inclusion in broad indices are also driving increased demand for Asian bonds”, says Kheng Siang Ng, Asia Pacific head of fixed Income and head of Singapore at State Street Global Advisors.
Those higher yields come with similar if not lower volatility than for comparable yields elsewhere. The ABF Pan Asia Bond Index Fund (PAIF) is an index-tracking ETF managed by State Street Global Advisors, and the fund aims to deliver returns of the Markit iBoxx ABF Pan-Asia Index that has a yield of 3.15 per cent,3 versus a global treasury yield of 1.63 per cent.4
To earn higher yields elsewhere, investors would have to purchase comparatively lower quality, if still investment grade, corporate debt — which tends to be more correlated to equity markets during crises — introducing more volatility to a broader investment portfolio.
In fact, based on a 60 per cent weighting in equity and 40 per cent in bonds, a hypothetical portfolio that holds 10 percentage points of the bond weighting in the Markit iBoxx ABF Pan-Asia Index offers a slightly higher expected yield compared with one that holds instead the Global Investment Grade Corporate Bond Index — and with an overall credit rating one notch higher.5
And while higher risk is undoubtedly a factor behind the higher yields on government bonds in Asia, they come with a bonus of lower correlation to US debt and equity. The shorter duration of Asian government paper, averaging seven years, also offers maturity sooner than that which is required for most developed markets. In a challenging return environment across asset classes over Q1 of this year, the hypothetical 60:40 portfolio with Asian government bond exposure held up better than the comparison portfolio by 0.46%.6
Foreign investors are warming to the region. Prior to the onset of the Covid-19 pandemic, overseas investors held about 39 per cent of Indonesian local currency bonds.7 Meanwhile, countries such as China and South Korea have seen strong buying interest through this environment, according to Asian Bonds Online data.
As inflation returns and the growth outlook falters in developed markets, this interest should continue to expand. To attract and retain foreign investment, countries including Singapore, China and Malaysia have set the withholding tax payable on bond cash flows to zero. Asian government bonds, backed by strong national balance sheets and solid economic prospects, deserve a place in every rounded portfolio.
1Source: Asian Bonds Online, 2008-2021. The AsianBondsOnline conducts an annual LCY Bond Market Liquidity Survey to assess liquidity conditions in LCY bond markets in emerging East Asia. The survey aims to provide an updated evaluation of the state of liquidity for each market in the region and identify potential areas for development. The survey is conducted through meeting interviews, phone interviews and e-mail correspondence with bond market participants. Bid-ask spreads represent the difference between the highest price that a buyer is willing to pay for a security (bid) and the lowest price at which a seller is willing to sell (ask).
2Source: Asia Bonds Online, 31 December 2009 – 31 December 2019. Government LCY bonds to GDP ratio = Total amount of government LCY bonds outstanding x 100 Annualized Nominal GDP. This indicator shows the size of government local currency (LCY) bond obligations as a percentage of nominal GDP. Government bonds include obligations of the central government, local governments, and state-owned entities. Bonds are defined as long-term bonds and notes, treasury bills, commercial paper, and other short-term notes.
3Source: Bloomberg Finance L.P., as of 31 March 2022.
4Source: Bloomberg Finance L.P., Bloomberg Global Aggregate Treasury Index, as of 31 March 2022.
5Source: Bloomberg Finance L.P., based on index holdings as of 31 March 2022.
6Source: Bloomberg Finance L.P., performance period from 31 December 2021 to 31 March 2022.
7Source: Asia Bonds Online, as of 31 December 2019.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.
Sample portfolio returns shown above are hypothetical and are based on the returns of the underlying market indices in the proportions shown above. This information is for illustrative purposes only. Market indices are unmanaged and not subject to fees and expenses which would lower returns. Neither index performance nor sample portfolio performance is intended to represent the performance of any particular mutual fund, exchange-traded fund or product offered by SSGA. SSGA has not managed any accounts or assets in the strategies represented by the sample portfolios above. Actual performance may differ substantially from the hypothetical performance presented.
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