This is a sponsored article from PineBridge Investments.
Bank of Japan (BoJ) recently raised the target rate to 25 basis points1 and announced its plan to reduce Japanese Government Bond (JGB) purchases by JPY 400 billion per quarter1. Earlier in March this year, the central bank increased the benchmark interest rate for the first time since 2007 to conclude eight years of negative interest rates, marking a historic step toward policy normalisation. With Japan included in the new J.P. Morgan Asia Credit Index (JACI) Asia Pacific Index introduced last year, the BoJ’s policy actions are significant for a potentially wider group of investors.
Japan has long been a key location in the Asia Pacific investment grade (APAC IG) investment universe within our analysis and research. While China’s property sector crisis dominated headlines in the past few years, our earlier research led us to believe in a cautious approach on some segments within China and to favor diversifying across Asia Pacific, including Japan and Australia.
J.P. Morgan’s move in March last year to introduce the JACI Asia Pacific Index into its J.P. Morgan Asia Credit family of indices further supports our conviction and our approach that the region needs to be viewed as a whole. The new JACI Asia Pacific Index expands the coverage of the flagship JACI Index to include debt from Japan, Australia, New Zealand, and other Pacific countries.
Investing in Asia Pacific blurs the traditional divide between developed markets and emerging markets, potentially posing problems for asset allocators that still look at the universe in a more traditional (and potentially outdated) way. However, we see two key benefits of doing so.
1. The addition of these markets makes for a larger and more dynamic universe
Compared to the JACI Index, the JACI Asia Pacific Index expands the universe dramatically, from US$800 billion in market capitalisation to US$1,265 billion as of 30 June 2024, and from 1,269 issues to 1,796.
China, which takes up a large portion of JACI at 35.5%, is reduced in the JACI Asia Pacific Index to only 22.5%, making room for Australia and Japan, which together make up 35.4%.
Top five markets in JACI versus JACI APAC
Source: Bloomberg, JP Morgan, PineBridge Investments, as of 30 June 2024.
At the same time, the new index remains very high quality, consisting of 88.5% investment grade bonds, compared with 85.4% for the JACI.
The additional markets have the net effect of dampening volatility, as shown in the table below.
Adding APAC IG helps reduce volatility
Source: JP Morgan, as of 30 June 2024. Past performance is not indicative of future returns.
Furthermore, the JACI Asia Pacific Index offers a slightly higher yield and lower duration than the JACI.
The JACI APAC Index provides an edge in yield and duration
Source: JP Morgan, as of 30 June 2024.
2. Adding APAC IG to a global IG portfolio reduces volatility and enhances returns
For investors only invested in global investment grade bonds, adding APAC IG to the portfolio helps add exposure to emerging markets but with the relative safety provided by the presence of several developed countries. Aside from Japan and Australia, these include markets classified as advanced economies by the International Monetary Fund, such as Hong Kong, South Korea, New Zealand, and Singapore.
It is also worth noting that the overlap between global IG (using as a proxy the Bloomberg Global Aggregate Corporate Index) and APAC IG is small: Australia and Japan make up only 2.2% and 2.5%, respectively, of the Global Agg Corp as of 30 June 2024.1 Investing in APAC IG therefore provides more effective exposure to the two countries.
As a cherry on top, investors not only retain the same overall credit quality – the Bloomberg Global Aggregate Corporate Index averages at A2/A3, while the average for JACI Asia Pacific Index is A2 – but also gain additional yield from adding APAC IG to the portfolio.
The attractive technicals of APAC IG (with low issuance meeting growing investor demand), generally steady fundamentals, lower duration, and lower credit-spread volatility all combine to make the asset class attractive. When added to an overall global IG portfolio, they also boost returns and lower volatility, as seen below.
10-Year annualised volatility
Source: JP Morgan, PineBridge Investments, as of 30 June 2024 . Past performance is not indicative of future returns. Asia IG represented by the JPM JACI Investment Grade, Global Aggregate Credit by the Bloomberg Global Aggregate Credit Total Return.
Our views on Japan
Rounding back to Japan, with the recent rate hikes and plan to taper bond purchase, BoJ Governor Ueda showed a distinctly more hawkish stance, stating that 0.5% is not the ceiling for rate hikes and the current level of interest rates is much lower than the neutral rate, despite previously mentioning that that the cost of waiting is not high.
We believe such rate hikes will have a marginal immediate impact on the credit metrics of Japanese high-quality issuers, while being positive over the longer term. In Japan, we currently favor megabanks and a select number of insurance companies.
For megabanks, the valuation loss on their bond holdings resulting from policy actions should be manageable, given the low duration of their JGB holdings. They are likely to be net beneficiaries, with profits receiving a boost from the reallocation of their cash holdings to JGB as interest rates rise. The megabanks have kept large cash balances in anticipation of this. Furthermore, the strength of the yen is helpful for the capitalization of the banks.
On the other hand, we also believe insurers are likely to benefit in the long term, enjoying higher investment returns in the higher interest rate environment. Most of them have been reducing holdings of foreign bonds and switching back to domestic bonds, particularly long-dated JGB, as the domestic interest rate rose. Insurers’ exposures to loans or real estate have not changed materially, and they have been prudent in taking risks.
Despite the more recent hawkish BoJ meeting, we believe that the rate hike cycle in Japan will be still gradual enough for financial institutions to manage asset risk in the higher interest rate environment, especially when the rate hikes are driven by rising wages. With rising interest rates at home while USD interest rates decline, Japanese companies may consider issuing more USD bonds. We will likely see more diverse issuers come to USD bond market, providing more investment opportunities.
As the line between emerging and developed Asia within the APAC IG universe becomes blurry, investors could consider tapping the attractive risk-adjusted opportunities from this asset class.
Click here to learn more about PineBridge’s Asia fixed income capabilities and our APAC IG solution.
Footnote
1 Source: Bloomberg.
Disclosure
Investment involves risks. Past performance is not indicative of future performance. In Hong Kong, This material is issued by PineBridge Investments Asia Limited, a company incorporated in Bermuda with limited liability, and has not been reviewed by the Securities and Futures Commission in Hong Kong. PineBridge Investments Asia Limited is registered as a Class A Registered Person with the Bermuda Monetary Authority pursuant to the Investment Business Act 2003 (as amended).
The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any republication of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
This is a sponsored article from PineBridge Investments.
