The Search for Income Continues
With interest rates at record low levels around the world - in fact in some countries they are even negative - it has become increasingly hard to find good levels of income that can satisfy client needs. In Asian fixed income markets, however, the situation is relatively promising. Asian USD credits provide an average yield of around 4.9%, rising to over 8.0% for high yield corporate credits (as at 29 January 2016). Yields for Asian local currency bonds are more varied, ranging from relatively low in markets such as Taiwan and Hong Kong, to as high as 7-8% for markets such as India and Indonesia. With most Asian economies likely to keep monetary policies accommodative, selective local currency bond markets also offer the potential for capital gains should central banks cut policy rates further.
The Asian fixed income asset class has grown significantly over the past 10 years with a growing number of companies looking to the capital markets for funding due to tighter bank lending regulations as well as to diversify their funding sources. Asian USD bonds have also seen an increasing local investor base supporting new issuances, which can help to mitigate capital flight risks when there is a decline in foreign appetite.
Asian Fixed Income Outlook
In light of the various macro risks we are seeing, volatility will prevail in 2016. Our unconstrained approach provides the Asian bond strategy with greater flexibility in this environment to both manage downside risks as well as to take advantage of opportunities. We believe carry will be a key driver of returns this year and we therefore maintain a preference towards the high yield sector for higher carry and greater spread buffer but we remain cognizant of idiosyncratic risks. Asian high yield credits also have lower correlation to US Treasury yields compared to the investment grade sector due to the high yield sector’s overall lower duration. The strategy’s flexibility to actively rotate into investment grade credits allows it to position more defensively during periods of volatility (given lower volatility of investment grade credits versus high yield) and also offers additional sources of return. Credit metrics for investment grade corporates (except those in the oversupplied sectors) look better compared to high yield as many such corporates have been actively reducing costs, capital expenditure and merger and acquisition activities into the current downturn. We believe credit selection and differentiation will be key to alpha creation in credits this year.
In Asian local rates markets, atypical of previous cycles, we believe we could see a divergence of monetary policy between Asia and the US. While Asian interest rates have historically increased in a US Federal Reserve (Fed) hiking cycle, Asia is today facing weaker growth prospects and benign inflation. This should mediate the correlation of monetary policy between the US and Asia. Hence, we believe most Asian economies could see monetary policy remaining accommodative despite the Fed embarking on its rate hiking cycle. In terms of Asian currencies, RMB developments and the Fed’s intentions towards its interest rate normalization process will be important near-term drivers. Tactical opportunities are typically more abundant in a volatile market environment and we look to take advantage of such opportunities as well as intra-regional currency opportunities to add value for the strategy.