Asian bond market proves favourite for yield-hungry investors

Asian debt offering notable premiums over developed-market sovereign equivalents and similarly rated US corporate bonds

PUBLISHED : Sunday, 18 September, 2016, 7:13pm
UPDATED : Sunday, 18 September, 2016, 9:45pm

The historically high spread between Asian credit bonds and US treasury bonds is making the Asian market a favourite for yield-hunting investors to capture sustainable returns while taking on less risk, according to experts.

“The reason we like Asian credit bonds is the higher ratings, lower default rates, and in particular, the historically higher spread levels,” said Jim Veneau, the head of fixed income at AXA Investment Managers Asia.

The growing preference for Asian bonds is echoed by Desmond Soon, head of Asia investment management and portfolio manager at Western Asset Management, a global fixed-income investment firm, who added that Asian bonds are offering notable premiums over developed-market sovereign equivalents and similarly rated US corporate bonds.

According to data from Bank of America Merrill Lynch, both investment grade and high-yield bonds and Asian credit bonds now offer superior returns on a risk-adjusted basis, compared with credit bonds from the US and other emerging markets.

For example, the spread between the yield of three-year Asian investment-grade bonds and US treasury bonds is 1.43 per cent, compared with spreads of 0.38 per cent and 0.3 per cent for the same type of bonds in the US and other emerging market, respectively.

In the case of three-year Asian high-yield bonds, the spread is 0.98 per cent, compared to 0.1 per cent and 0.39 per cent in the US and other emerging markets.

Asian credit bonds are also providing superior returns across bonds of all rating cohorts and maturities.

“Although we have seen a compression of spread levels lately, which means Asia offers less advantages than other regions, we think the premium will eventually resume,” said Veneau.

The rebound in premiums over US treasury bonds is already happening in Asia.

According to a note from Societe Generale, while Asian nominal yields have been on a downtrend this year, there have been some rebound in real yield differentials between Asian government bonds and US treasury bonds, thanks to a more benign inflation backdrop in Asia which translates into higher real yield.

In particular, the differentials for Malaysia, Indonesia, Korea and Taiwan are near their one-year widest points, according to the bank.

“Looking back at one, three, five and ten years, when you combine historical facts like low default rates and spread premium as well as risk adjusted excess returns, this is a sustainable trend,” said Veneau.

Given the strong returns, the risks in the Asian credit bond market are declining.

“Compared with other emerging markets, Asia is much safer on a risk-adjusted basis,” said Soon.

Veneau said macro conditions have improved right across Asia, providing attractive growth rates in a world of very sluggish recovery.

Volatility of the Asian credit bond market has decreased significantly in the latest period, with Asian high-yield markets in particular evolving to become less volatile than US and other emerging markets over one and three years, according to AXA Investment Managers.

In addition, the default rate in the region has been consistently lower than the global average.

According to data from Moody’s Investors Service, the default rate in the Asia-Pacific credit bond market in the year to end March was 1.13 per cent, compared with a global average of 1.76 per cent.

For the past five years, the figure for Asia-Pacific was 1.42 per cent compared to a global average of 5.28 per cent.

However, given the uncertainties in the Federal Reserve’s monetary policy, traders are now favouring shorter maturities as it continues to hold on stoking inflation, which erodes the value of debt maturing decades in future.

“A short duration strategy in the Asian credit market can achieve yield enhancement, with less credit exposure than in the US or Europe’s short duration strategies, said AXA Investment Managers.

The JPMorgan Asian Credit Index, which gauges the short-dated Asian credit segment, has offered better risk adjusted returns, delivering 87 per cent of the return of the whole index, with less than 75 per cent of the volatility.