Asian bonds win favour for long-term potential

PUBLISHED : Saturday, 08 October, 2005, 12:00am
UPDATED : Saturday, 08 October, 2005, 12:00am


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Financial advisers always emphasise that investors should maintain a diversified portfolio consisting of bonds, stocks and cash in varying percentages, depending on individual circumstances and objectives.

Because bonds typically have a predictable stream of payments and repayment of principal, many people invest in them to preserve and increase their capital or to receive dependable interest income.

As with all other investment instruments, bonds are not risk-free and are subject to currency, economic, social and political factors, which is why a long-term investment horizon is often recommended.

Emerging market bonds are particularly prone to volatility. Financial crises over the past 10 years have hit some high-profile emerging nations and led to significant movements in the prices of emerging market bonds. The capitalisation of domestic Asian bond markets has roughly doubled since the Asian crisis, from about 25 to nearly 50 per cent of GDP.

Cecilia Chan, HSBC director, and head of fixed income, said the Asian bond market was looking increasingly attractive over the long-term. She said factors such as the revaluation of the yuan pointed to a potential upward trend for Asian currencies.

There is also evidence that the currencies could appreciate due to being undervalued and trading at a discount to pre-crisis levels. In spite of rapid growth, Asian local currency bond markets remain relatively undeveloped compared with the United States.

While most Asian investors continue to favour dollar-denominated deals, they are making adjustments in the structure of their portfolios, and the amount of new cash available for new investments is sizeable.

Earlier this month, HSBC launched a new Asian Currencies Bond fund designed to offer investors an opportunity to diversify from US dollar or HK dollar assets. The currency bond fund, a relatively new fund class in Hong Kong, seeks to benefit from potential Asian currency appreciation against the US dollar while aiming for enhanced yield over cash with relatively low risk.

A minimum of two thirds of the fund is invested in Asian currencies and one third in high-yield credit. Ms Chan said in terms of duration and credit management the fund would be managed in an active style.

'We are looking at a longer-term story rather than a short-term story,' said Ms Chan, who leads a team of Asian investment specialists in managing HSBC fixed-income portfolios.

She said looking forward there were several reasons to expect the Asian currency bond market to continue to grow.

'In general, Asian economies are showing good positive momentum. The region is likely to remain the fastest growing part of the world for the foreseeable future, and its growth will produce an expanding population of firms that will finance some of their operations with debt as well as equity.

'Asia is a high savings region, and its immense pool of savings will most likely seek new investment opportunities, which could include the Asian currency bond market,' Ms Chan said.

She said key drivers included the end of the US cycle of interest rate rises which were expected to peak at about 4 to 4.25 per cent.

'Higher oil prices make us think that the US interest rate rise cycle is close to its peak,' Ms Chan said. 'The Fed is unlikely to raise rates much further for fear of suffocating growth.'

There has also been a steady increase of Asian credit upgrades that continue to help lower Asian spreads over US Treasury bonds. In addition, Asian currencies are expected to continue appreciating in value.

This has happened while financial institutions and corporations have taken full advantage of the favourable economic environment to improve their profitability and strengthen their balance sheets.

'We think the Asian credit upgrade story remains intact as most Asian countries have been awarded positive ratings over the past 12 months,' Ms Chan said.

While the general consensus of investing suggests that bonds should be avoided when interest rates are rising, investors also need to look at the bond maturity period. She said bonds with different maturity periods reacted differently to rate rises.

Short-dated bond yields were much more sensitive to interest rate changes while long-dated counters reacted more to inflation expectations.

'It is a matter of monitoring the situation carefully,' Ms Chan said.

Asian bond prices are well supported by relatively accommodative monetary policy, abundant liquidity and improved credit conditions despite the Fed's rate increases.

HSBC also offers an Asian Bond Fund. With nearly US$66 million under management, the HSBC Asian Bond Fund aims to achieve a reasonably high income while maintaining a prudent policy of capital conservation, through investing in fixed-interest securities and government bonds within the Asian region (except Japan), with an average maturity of two to five years.

HSBC also offers a Hong Kong Dollar Short Maturity Fixed Income Fund. Ms Chan said the investment strategy of the fund was based on three major areas, a diversified portfolio of short-term securities, instruments and obligations which are issued by entities carrying a minimum short-term rating of A2/P2 or a long-term rating of A/A3.