Keep a special eye on India and China

Five out of the six funds in the Investment Association sectors with Asia/Asian bond or debt in the title posted a loss for the 12 months to November 19 2015.

Longer-term performance is more palatable, with the three funds with a five-year track record delivering a positive return. But with Asian growth, particularly in China, continuing to slow and interest rates in the US likely to move higher, what is the outlook for the asset class?

Michele Leung, director of fixed income indices at S&P Dow Jones Indices, notes the S&P Pan Asia Bond index – which covers 10 countries – has gained 2.4 per cent for the year to date to November 18, outshining the S&P US Aggregate Bond index rise of 1.2 per cent. But she points out that historically, the Pan Asia Bond market has been more volatile than the US, with the fluctuation in Asian currencies a key contributing factor. Therefore on a risk-adjusted returns basis, the US bond index has fared better across one and five-year periods.

That said, she notes: “In terms of market size, the market value tracked by the S&P Pan Asia Bond Index has expanded more than threefold to $8trn (£5.2trn) since index inception [in December 2006], of which the S&P Pan Asia Corporate Bond Index grew significantly to $2.2trn and it currently represents 27 per cent of the overall exposure.”

Corporate credit in Asia appears to have delivered the best performance, with a five-year gain of 5.3 per cent versus the broader index gain of 4.1 per cent. On a regional basis, China delivered a robust 6.3 per cent increase for the year to date, while the S&P Indonesia Bond index is the “most volatile market” among the 10 countries, says Ms Leung. But in the past five years, India has been the standout performer with the S&P BSE India Bond index gaining 9.1 per cent over five years.

Donald Armstad, business development director, fixed income at Aberdeen Asset Management, notes in a recent outlook that while Asian markets are out of favour, “investors risk overlooking one of the most promising investment stories in the world right now – India”.

He says a key driver is the decision by Raghuram Rajan, governor of the Reserve Bank of India, explicitly to target inflation, specifically consumer price inflation of 4 per cent, plus or minus two percentage points.

Mr Armstad explains: “Why is this important for fixed income investors? Well, if Mr Rajan manages to keep inflation at these levels, then investors must ask themselves why 10-year local currency government bonds yield more than 7.5 per cent. We think Indian country risk is massively mispriced. Rupee-denominated government bonds should not yield this much. The risk premium for India is too high and should fall.”

China could also become a focus for bond investors in future, especially as the IMF recently announced it will put forward the renminbi (RMB) for inclusion in its basket of reserve currencies, the Special Drawing Rights (SDR). Jan Dehn, head of research at Ashmore, says: “In our view, all investors should have a China strategy, in the way most institutional investors have a US strategy.

“China’s RMB is ultimately destined to replace the US dollar as the world’s primary reserve currency, while China’s central government bond market will become the world’s primary reference market for fixed income.

“This prediction is simply the inevitable consequence of China’s size – China’s population is more than four times larger than that of the US. If per capita GDP grows at the average pace sustained between 2011 and 2015 in both the US and China, then China’s per capita GDP will overtake that of the US by 2043.”

Jim Veneau, head of fixed income Asia at Axa Investment Managers, agrees that the inclusion of the RMB into the IMF reserve currency basket could be a big driver for Chinese fixed income, as “capital account opening will accelerate and a significant flow of central bank, sovereign wealth and other institutional money will flow onshore over a period of years”.

He adds: “As this happens, the dim sum bond market [bonds issued outside China but denominated in RMB] will converge with the onshore market and we will eventually have one CNY (yuan) bond market, with a significant level of foreign ownership. The onshore Chinese bond market is already the world’s third largest and ranges in credit quality from sovereign Chinese government bonds (CGBs) and highly strategic policy banks to speculative corporate bonds.”

Nyree Stewart is features editor at Investment Adviser

WHERE TO INVEST

Koh Liang Choon, head of fixed income at Nikko Asset Management, says:

“We have moved to an underweight duration on Thai and Korean bonds. Owing to a larger forecasted budget deficit for fiscal year 2016, the Thai government’s funding needs will increase by more than 30 per cent, and the Public Debt Management Office has announced that gross bond supply will rise by about 13 per cent, with a deliberate increase in the supply of longer-tenure bonds. This puts a steepening bias to the bond yield curve.

“For Korea, we hold the view that the Bank of Korea will leave rates unchanged for the rest of the year, as recent economic numbers have printed better than expected. In contrast, we expect government bonds with higher carry and less correlation to US Treasuries, such as India, Indonesia and Malaysia, to fare better going forward.”

Wai Mei Leong, high yield fund manager, Eastspring Investments, says:

“While China faces formidable challenges ahead as it tries to balance between structural reforms and the need to maintain growth and financial stability, we do not expect a hard landing of the economy. Wage growth and urban migration continue to support consumer demand. There are also still reasonable resources and policy levers for the government to support the economy.

“Furthermore, there will always be stronger, better-run companies which can weather periods of economic downturn. This is why credit differentiation is very important in this environment to identify the better-quality high yield names which can potentially outperform.”