Why the appeal of Asian bonds could entice foreign buyers?

Given Asia’s diversity and growth potential, we look at which markets and bond types appeal most to overseas investors and the underlying reasons why.

Since governments generally sell bonds to fund internal spending, most sovereign debt is issued in the market’s local currency. Domestic investors are more likely to buy such bonds, given these participants are often the managers of retirement or insurance funds who need to provide pensions or other annuity-type payments.¹ As such, local-currency government bonds are a relatively low-risk way of managing assets and liabilities.

The potentially higher yields on offer may attract foreign buyers who specifically invest in local-currency government bonds and will, therefore, choose to hedge out their currency risk. Other investors may want to actively embrace foreign exchange risk because they believe the local currency will strengthen.

Globally Competitive, High-Quality Issuers

Foreign investors in Asia usually gravitate towards high-quality corporate bonds, preferably those issued in ‘hard’ currencies like the US dollar or euro. A good example is the debt of semiconductor chip manufacturers in South Korea.²

In contrast, bonds issued by little-known, domestically focused companies attract less attention from foreign participants. This lack of appetite makes it unlikely that such a business would attempt to come to the market with a foreign-currency bond. If it did, it would need to offer an elevated high yield to entice investors.

Which Markets Are Popular with Foreign Investors?

According to the Asian Development Bank (ADB), South Korea has among the highest percentage of foreign investors as bond holders. Data shows that these participants held 20.3% of local-currency government bonds at the end of September 2023.³ Conversely, Vietnam sees very few foreign investors in its local-currency sovereign issuance. Instead, the market is dominated by banks and insurance companies, which make up 99.4% of buyers.⁴

South Korea May Gain Entry to International Bond Indices

Remaining with South Korea, the finance ministry and the Financial Supervisory Service are considering changes to trading regulations to make it easier for local debt to be included in the influential FTSE Russell global bond index. South Korean bonds will also feature on the Euroclear settlement platform in July 2024.⁵

Inclusion in a leading global bond index may lead to more significant foreign investment as fund manager investment mandates are often benchmarked against these indices. As markets in the region mature, we may see more Asian debt may be included in these indices.

Risk Versus Reward Across Asian Local-Currency Bonds

Government or quasi-government bonds have a different risk profile than corporate bonds. This is because, in theory, governments can generate local currency to repay interest and principal as required.

In the case of corporate bonds, there is the risk of default if the issuing company performs poorly or faces bankruptcy. The credit risk inherent in any corporate bond is measured by the yield spread above a ‘risk-free’ government bond. Investors prepared to move down the risk curve expect to be rewarded for taking on this extra risk by receiving a higher yield from the bond in question.

History has shown that the value of a particular local currency in comparison to a major currency like the US dollar or the euro may fall sharply. Many investors choose to hedge out risk by using currency forwards. The cost of this hedging can eat into returns and is an essential variable for foreign participants to consider.⁶ Bond investors must assess the prospect of not being repaid and the risk that the currency could be devalued.

Asian Economic Growth Forecasts Exceed Those of Western Economies

The International Monetary Fund (IMF), in its April 2024 World Economic Outlook report, expects real GDP growth in emerging and developing Asia to reach 5.2% in 2024. In comparison, real GDP growth for 2024 is forecast at 2.7% for the US and only 0.8% in the euro area.⁷

This divergence reflects the region's strong potential, especially compared to more mature Western economies. Population growth remains a favourable tailwind for many Asian markets as it boosts the labour force and creates more consumer demand for goods and services.⁸

Foreign Investors Continue to See Value in Local-Currency Bonds

Foreign investors in the local-currency bonds of certain Asian markets are likely attracted to the relatively high current yields available rather than potential currency gains. Positive macroeconomic fundamentals also play a role in reducing investors’ fears about the potential for currency devaluation.

In the medium term, domestic investors like banks, pensions and insurance funds will likely remain the predominant holders of local-currency bonds across Asia. Over a longer time frame, there may be an uplift in overseas investment in the foreign-currency bonds of those regional companies that have become acknowledged global leaders.