Hedging against inflation
High inflation concerns are leading more investors to look at fixed-income securities, especially high-graded credits, according to analysts.
Asian borrowers facing refinancing needs will probably accept higher absolute yields, according to Antoine Gros, Calyon's head of debt and credit markets for Asia ex-Japan.
'Investors will need to have a medium-term view and holding horizon, and be prepared to support negative valuations of their bond portfolio in the short term because inflation concerns keep putting pressure on rates. But taking a longer-term view, if inflation can be kept under control, fixed income markets should perform well.'
Mr Gros expects stronger appetite for inflation-linked bonds which may lead to an increase in issuance by Asian sovereigns.
'But, on the borrower side, especially for sovereign issuers, one needs to be confident that inflation will remain at an acceptable level to manage the cost of funding. It is also quite likely that any inflation-linked bonds will be issued in local currencies rather than G3 currencies [US dollar, Japanese yen and the euro],' he said.
Mr Gros said that now could be a good time to invest in inflation-linked bond funds, but only with a short-term view. 'Investing in inflation-linked bond funds is a good way to protect investors' assets against uncertainly on future inflation levels,' Mr Gros said. 'But it all depends on the readiness to exit efficiently from this type of investment once inflation comes back to more reasonable levels.'
Other than South Korea, which is among the few Asian countries to have issued inflation-linked bonds denominated in its currency, there are few other countries in Asia that have issued inflation-linked bonds.
Inflation-linked bonds have their principal indexed to inflation. Therefore, when the principal increases with inflation, the subsequent coupon payments are adjusted to reflect the change.
Asset manager State Street Global Advisors said it would look into introducing emerging-market bond funds.
HSBC Asset Management recently launched an emerging-markets inflation-linked bond fund which invests in local currency-denominated inflation-linked bonds issued by Brazil, Chile, Colombia, Mexico, South Africa, Poland, Turkey and South Korea.
HSBC said that the market size of emerging markets inflation-linked bonds was about US$200billion to US$250 billion.
Patrice Conxicoeur, chief executive of Sinopia Asset Management (Asia-Pacific), the quantitative investment specialist of HSBC Global Asset Management, said the potential return of the bond fund was 10 to 12 per cent. The fund aims to offer investors opportunities to benefit from intensifying inflation in emerging markets and currency appreciation. Mr Conxicoeur said: 'There is some local currency risk. Hong Kong is subject to US inflation and global inflation.'
JP Morgan Private Bank head of Asia investments Adam Tejpaul said that while emerging-market inflation bonds offered potential upsides, the bank was advising investors to focus on more liquid markets such as the US and Europe.
Lieven Debruyne, chief executive of Hong Kong and regional head of retail business in Asia at Schroders, said: 'Emerging-market bond funds offer some level of hedge against inflation. But there's no such thing as a perfect hedge.'
Mr Debruyne said because the majority of emerging-market inflation-linked bonds were issued by Latin American countries they might not appeal to Asian investors.
Other than fixed-income securities such as inflation-linked bonds, Mr Debruyne said that gold and metals might offer a good hedge because the level of inflation was also influenced by the rise in commodities prices.
Thomas Della Casa, global head of research at Man Investments, said global macro funds had been generating good returns. Global macro funds returned 11.1 per cent last year and 5.4 per cent in the first five months of this year.
The equities market is bearish and this is creating opportunities for global macro fund managers which use long/short strategies through stock picking and sector divergence. 'Long positions generally remain limited, and most equity hedge managers have small net long exposure, if at all,' Mr Della Casa said.
He said that while multi-strategy managers still had a high percentage of liquid assets, enabling them to take opportunistic positions, the outlook for event-driven opportunities was more mixed because the sell-off in credit markets since August 2007 had created a substantial opportunity in distressed securities. Many issues were trading at a substantial discount to their intrinsic value.
'We believe that the distressed market is going to take more time, despite expectations that distressed debt investing, which has thrown up few opportunities recently due to historically low default levels, will again prove lucrative as corporate defaults rise. However, the distressed debt market will probably be one of the top performers,' Mr Della Casa said.
