Asian Local Currency Bonds Give Equity A Run For Its Money
New investment possibilities in Asia
The rise in issuance of local currency government bonds in Asia is presenting more opportunities for investors to access the region's growth. As well as a growing pool of renminbi-denominated government debt in China, debt programmes in regional economies such as Singapore and Hong Kong are set to add to the availability of high-grade investible assets.
In addition to $6bn in US dollars and euro-denominated green bonds, for instance, Hong Kong also tendered RMB5bn in offshore green bonds in 2021. With the region's average debt rating of A, its quality is slightly below that of the global aggregate, at AA-.1
Diversification in focus
This should be a draw for those looking to diversify their portfolio exposure. Despite the acknowledged benefits of spreading portfolio risk across asset classes and geographies, many foreign investors have tended to lean heavily on equity when investing overseas.
The Thinking Ahead Institute, the investment research group, noted in 2018 that overseas equity holdings in the top seven markets by pension fund assets, what it terms the P7, had risen over 20 years from one-third to three-fifths of total equity holdings on average. For bonds, however, home bias still exists. Domestic fixed income weightings accounted for 71 per cent of total holdings, down just 15 percentage points from 86 per cent in 1998.
The long-term performance of Asian government bonds illustrates how they can add value. Over a volatile couple of decades, encompassing the global financial crisis (GFC) of 2008, the Markit iBoxx ABF Pan-Asia Index has delivered an annualised return of 5.4 per cent since its inception in January 2001. This is higher than the equity return of 3.1 per cent over the same period, which came with far higher volatility.2 Notably, the equity slump during the GFC erased seven years of gains in the MSCI All Country Asia Index, according to Bloomberg data. By contrast, the region's government fixed income experienced a very modest impact, even when accounting for currency effects (as measured in US dollar terms).
Meaghan Victor, head of SPDR ETFs Asia Pacific distribution at State Street Global Advisors, explains how this resilience has manifested during the pandemic. “During Q1 2020, when markets were first processing the economic impact of Covid-19, global equity markets were down more than 20 per cent, while crude oil was down over 70 per cent. Markit iBoxx ABF Pan-Asia Index performance, however, held up, falling just 2.9 per cent in that quarter—and ending with a positive return of 9.5 per cent over the calendar year 2020.”
The steadier performance delivered by the diversified bond exposure means that investors need not focus as much on the market timing and country selection that can so influence returns in these sometimes volatile and divergent regional equity markets.
Getting good access
The universe of funds offering access to Asian government and quasi-government bonds is still limited but includes relative old-timer, the ABF Pan Asia Bond Index Fund (PAIF). The fund, launched in 2005 by Asia-Pacific's leading 11 central banks and monetary authorities and domiciled in Singapore, was the first Asian local currency bond exchange traded fund (ETF) and was valued at $3.5bn as of March 31, 20223.
Designed to facilitate exposure to the asset class, it tracks the Markit iBoxx ABF Pan-Asia Index, offering liquid access to the bonds of eight of the region's economies. As the outlook for economic growth becomes more uncertain and inflation reemerges around the globe, the constituent markets are unlikely all to experience the same conditions, thus adding an extra layer of diversification.
The use of an ETF as the vehicle is a further boon for investors wary of potential liquidity squeezes in emerging markets: even when underlying bond markets were at times thinly traded, on-exchange trading in bond ETFs such as PAIF continued, providing an additional source of liquidity.
This liquidity should only improve as the pool of investible assets, as well as the investor base, expands across the region. India, for instance, has been gradually opening up to foreign investors and has the potential to be added to broader bond indices further down the line. With steady GDP growth rates across the region, there is further headroom for government fixed income issuance to grow given modest debt to GDP levels — especially when compared with developed markets, whose borrowing levels are far more constrained.
Of course, there are risks, notably related to rate rises in the US, where consistent with hawkish but cautious comments from Fed, the market anticipates a series of meaningful rate rises, risking stifling the global recovery as it gets underway. The geopolitical crisis surrounding the invasion of Ukraine has resulted in a stronger US dollar as a safe-haven asset that can weigh on emerging economies, including those in Asia.
However, the diversification benefits of exposure to Asian economies in different phases of the cycle offer reassurance that some markets can still hold up even in a difficult environment. As we enter a period of increased economic uncertainty, past performance suggests that Asian local currency bonds can continue to provide stable regional exposure versus volatile equity markets.