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Growing opportunities in East Asian local currency bond markets

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This is a sponsored article from State Street Global Advisors.

Having grown considerably over the past decade, the East Asian local currency government bond market has become an asset class that global investors should find hard to ignore. Today, the markets that make up the ABF Pan Asia Bond Index have a total market capitalisation of about US$7.5 trillion1, a very significant part of the global bond universe.

Matthew Arnold, CFA
Head of SPDR ETFs, Singapore
State Street Global Advisors

“To put some context around those numbers, the investable US high yield corporate bond universe totals about US$1.5 trillion2,” said Matthew Arnold, CFA, Head of SPDR ETFs, Singapore at State Street Global Advisors. “So clearly the East Asian local currency government bond markets present a significant opportunity for investors today.”

While not yet a mainstream asset class for many investors, East Asian local currency government bonds offer investors the prospect of higher yields and exposure to the favourable growth characteristics of the region. In a recent interview, Arnold talked about the demand for Asian fixed income and the role of Asian local currency bonds in a global multi-asset portfolio.

It was a very strong year for equities in 2017, but how was the demand for emerging markets and Asian bonds?

While equity markets were incredibly strong in 2017, and we saw investors large and small allocating to equity funds and ETFs, this did not come at the expense of fixed income. Last year, there was significant buying of bond ETFs, particularly those that provided exposure to the USD and emerging markets fixed income.

I think one of the key drivers last year was that investors are getting more comfortable with ETF structure as a means of investing in bonds. With yields remaining low in much of the world, investors are very focused on reducing their costs and getting value for money. Fixed income ETFs are also very easy to use and enable investors to buy a portfolio of bonds in a single trade using the same infrastructure as listed equity trades.

With regards to Asian local currency bonds in particular, most of the demand was coming as part of broad global emerging market bond funds and mandates. Among the main regions in the local currency bond universe – Asia, Latin America and Europe – there was more demand for Asian bonds as investors appeared to favour the superior growth and structural changes we see in the region today.

From a multi-asset portfolio perspective, how should investors think about Asian local currency bonds?

Asian local currency bonds offer many benefits to the typical multi-asset investor. For instance, if you look at a global multi-asset portfolio that invests in developed market equities, bonds and real estate, Asian local currency bonds should be something of a diversifier, with unique risk and return characteristics. From a fundamental perspective, the region is generally experiencing strong economic growth, and the fiscal characteristics of the countries that make up the ABF Pan Asia Bond Index are the envy of much of the developed world.

While the US Federal Reserve has started to raise interest rates, rates remain at rock-bottom levels throughout much of the world, so the yield pick-up offered by Asian local currency bonds should be desirable for investors around the world.

How should investors factor in currency movements when investing in Asian local currency bonds?

Forecasting currencies is a notoriously difficult proposition, one arguably made even more difficult today given the assortment of ‘unconventional monetary policies’ employed by central banks around the world. Relative currency performance is driven by a range of factors, from technical to fundamental, and usually includes variables such as relative economic growth, inflation and interest rate expectations. If one were to generalise, you could say that, over the long term, currencies tend to do well where the local economy is growing strongly and monetary policies are sound and focused on maintaining price stability. This is all-important for international investors in Asian local currency government bonds. Over time, much of their total returns will be driven by the performance of the basket currencies relative to their home currency. This means that investors should hold a generally positive view on the prospects for Asian currencies relative to their own.

Invest in Asian local currency bonds with ABF Pan Asia Bond Index Fund. Visit www.abf-paif.com to learn more.

1 Source: Amount outstanding in USD, Asia Bond Monitor (November 2017), Asian Development Bank as of 30 September 2017.
2 Source: Bloomberg, total amount outstanding of the Bloomberg Barclays US Corporate High Yield Bond index is US$1.34 trillion as of 31 December 2017.

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