Emerging market debt (EMD) has suffered during the recent global turmoil for multiple reasons. First, it has been considered a risk asset and so has seen investors exiting it for safer investments, even though many key central banks have cut rates and started their own asset purchases. Second, the grab for yield and relatively strong performance of emerging market funds meant investors were fairly 'long' EM investments ahead of the turmoil. Third, for local currency debt there has also been the double impact of the aggressive bounce in the USD. Last, a number of emerging markets have economies that are heavily exposed to commodities and suffered, in particular, when oil prices fell sharply.
Year to date, China bonds showed relative strong performance versus its emerging market peers, with the country recording both FX and price gains. Rate cuts from the central bank and an aggressive early lock-down to deal with COVID-19 have delivered some support for bonds but that cannot explain fully the outperformance. This stability appears to be more about the CNY’s growing importance as a reserve currency and the fact that Chinese bonds have been adopted domestically as an alternative safe haven to US Treasuries just as foreign investors are increasing investments into Chinese renminbi bonds.
The broader Asian bond markets find themselves pulled in opposing directions. On the one hand, yields are being depressed by continued monetary easing as central banks around the world continue to slash interest rates to revive stalling economies. On the other, yields are being pushed up by the global flight to safety as some foreign investors exit certain Asian bond markets. Foreign outflows from Asian bonds totalled US$17.28 billion in March – the highest since January 2013.1
Such mixed driving factors of Asian bond performance can give the impression of greater and ongoing volatility for the asset class. But Asian bonds are not a monolithic entity, and these contradicting forces affect each sub-category differently. This diversity is the source of the potential for pockets of opportunity.
Asian Bond Market Divergence
After weeks of battling it out, OPEC+ nations – except for Mexico – reached a historic agreement on 10 April 2020 that would see crude production cut by 10 million barrels per day beginning May. However, this did little to support oil prices, which slid further, at one point falling below the US$20 per barrel mark. The size of the crude oil glut was also starkly revealed when an expiring May contract for West Texas Intermediate crude fell into the negative territory on April 20, driven by fears that there would be nowhere to store the delivered oil.
The prospect of continued depressed oil prices, however, is a near-term boon for most Asian countries, including China, the world's largest net oil importer, Korea and Taiwan. Exceptions are a few net exporters such as Malaysia, Vietnam, and Brunei.
The fall in energy prices also offsets the impact on inflation, a result from that a number of emerging market currencies have weakened significantly in the past months. The combination thus far means that headline inflation is still headed lower. This will be helpful for central banks, providing them with more room to ease monetary policy, which may place further downward pressure on bond yields.
The impact of a strong US dollar on Asian bonds amid the global flight to safety also affects each country differently. Countries like Indonesia and India, which are facing twin deficits in their budget and current accounts, are more reliant on foreign inflows and thus more exposed.
Central Banks to The Rescue
COVID-19 presents a different set of challenges versus the previous crises but, crucially, central banks have acted quickly. Rate cuts and bond support programmes were initially deployed to limit the worst effects of the economic slowdown on households and businesses.
A key objective for central banks is to keep credit flowing to corporates. In China, which remains the brightest star in the Asian bond constellation, first-quarter corporate bond defaults fell 30% year-on-year as the government pressured banks into keeping enterprises floating with easy financing.2
On the other side of the globe, bond buying programs for corporate bonds have been reactivated by the US Federal Reserve (the Fed), European Central Bank and Bank of England. The Fed has announced it will also purchase corporate bond ETFs, and an unheard-of foray into buying bonds that had recently lost their investment-grade status – so-called 'fallen angels'.
Potential Attractive Entry Opportunities
Despite contradicting forces on Asian bonds and divergence within the asset class itself, we believe, on balance, that overall yields will trend lower – which may create attractive entry opportunities for those practising careful asset selection.
Given the degree of the sell-off, there is scope for a rebound. Positive returns in Asian bonds can come through various sources: gradual economic recovery; rebound in local currency bonds against the USD; and central banks starting to buy domestic bonds.
The ABF Pan Asia Bond Index Fund (the 'PAIF') is an authorized unit trust in Hong Kong and Singapore only. Authorization does not imply official recommendation. Nothing contained here constitutes investment advice or should be relied on as such. Past performance of PAIF is not necessarily indicative of its future performance. Distributions from PAIF are contingent on dividends paid on underlying investments of PAIF and are not guaranteed. Listing of PAIF on the Hong Kong Stock Exchange and the Tokyo Stock Exchange does not guarantee a liquid market for the units and PAIF may be delisted from the Hong Kong Stock Exchange and/or the Tokyo Stock Exchange. Investors should read the PAIF's prospectus including the risk factors. The Prospectus for PAIF is available and may be obtained from State Street Global Advisors Singapore Limited or can be downloaded from www.abf-paif.com*.
All the information contained in this website is from SSGA and as of date indicated unless otherwise noted. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA's express written consent. This website and the information contained herein may not be distributed and published in jurisdictions in which such distribution and publication is not permitted.
All forms of investment carry risk, including the risk of losing all of the invested amount. Such activities may not be suitable for everyone.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.
Securities lending programs and the subsequent reinvestment of the posted collateral are subject to a number of risks, including the risk that the value of the investments held in the collateral may decline in value and may at any point be worth less than the original cost of that investment.
Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates rise, 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.
Diversification does not ensure a profit or guarantee against loss.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns. Frequent trading of ETF's could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.
The Markit iBoxx ABF Pan-Asia Index referenced herein is the property of Markit Indices Limited and is used under license. The PAIF is not sponsored, endorsed, or promoted by Markit Indices Limited or any of its members.
State Street Global Advisors Singapore Limited: Hong Kong address: 68/F, Two International Finance Centre, 8 Finance Street, Central, Hong Kong. Telephone: +852 2103-0288. Facsimile: +852 2103-0200.