Within this article we provide an in depth look at our approach to investing in Asian bonds within our PruFund funds.
- PruFunds have been invested in Asian bonds for 10 years with the allocation growing over time
- The journey took several years as Asian bond markets grew, deepened, and developed
- Asian bond yields have fallen in recent years but still offer better real returns than developed market corporate bonds
- A move to an inflation targeting monetary policy framework by a number of Asian central banks has resulted in lower, and more stable inflation rates across the region
- Asian bonds remain a diverse asset class so active management is very important
- The Asian bond manager, Eastspring Investments, have significant experience, resource and on the ground presence in this asset class
- Fund managers can add further value by adjusting positioning across dollar and local currency, as well as exposure to off-benchmark sub-asset classes like High Yield and dedicated China
- Performance ahead of developed markets corporate bonds since larger allocation in 2015
The value of any investment and any income taken from it can go down as well as up so your customer might not get back the amount they put in.
We can’t predict the future. Past performance isn’t a guide to future performance.
Developed market corporate bond markets can trace their origins back many decades and in the case of some government bond markets, hundreds of years.
Asian bond markets are relatively new by comparison. As recently as the late 1990’s dollar-denominated debt was the main source of capital for companies, with Asian central banks setting a peg between the domestic currency and the US dollar.
This arrangement worked fine until Thailand ran out of foreign currency to support its peg to the US dollar and was forced to float (and massively devalue) the Thai baht. The crisis spread across most of Southeast Asia, hitting confidence and demand as a result, leading to poor economic performance. In the wake the crisis governments across the region realised they needed to develop domestic bond markets to provide localised sources of funding to serve the needs of domestic businesses. In this way, the crisis ended up sowing seeds for positive change in the region.
From its beginnings in the 1990s, there have been several important milestones which bring us up to the present:
- Asian Bond Market Initiative –launched in December 2002 to strengthen financial stability and reduce the region’s vulnerability to the sudden reversal of capital flows
- Asian Bond Fund 1 – launched in 2003 to provide a vehicle through which Central Banks could invest some of their reserves whilst also helping to develop capital markets in the region
- Asian Bond Fund 2 – launched in 2004 and designed to provide access to listed bonds and passive bond funds also accessible to retail investors
- ASEAN+3* Bond Market Forum – established in 2010 to encourage standard market practices and alignment of regulations relating to cross-border transactions in the region
- The Credit Guarantee and Investment Facility – created in 2010 to enable companies to issue local currency bonds with longer maturities and reduce their dependency on short-term foreign currency borrowing. Effectively, the facility would pay bondholders in the event of a default.
*Association of Southeast Asian Nations (ASEAN) and the People’s Republic of China, Japan, and the Republic of Korea— known as ASEAN+3.
Several countries also embarked on a journey of prudent fiscal policy that saw large reductions in debt to GDP levels.
Improvements in corporate governance, legal frameworks, liquidity and market breadth have been crucial, with Asian bonds share of global debt increasing dramatically in the last 20 years.
Despite all the progress we still see a long-term discrepancy between strengths of companies and countries in Asia and valuations. Credit spreads are still higher despite the continual improvement of credit ratings.
Economic evolution in Asia
Over the past 20 years inflation in Asian economies has fallen. This provides a more stable macroeconomic environment for a bond investor. The T&IO Long Term Investment Strategy team (LTIS) expect inflation across many Asian and other emerging market economies to continue to improve over the long term. This view is based on more central banks targeting inflation and continuing economic development. However, we acknowledge there are greater inflation risks in emerging economies than developed markets, and some countries may not improve.
Figure 1: Inflation in Asian economies
Source: Treasury and Investment Office, May 2021. Underlying data from DataStream as at 15th March 2021
Asia has been at the forefront of a trend where emerging market central banks have behaved more like those in developed markets. More are explicitly targeting inflation and able to use monetary policy as a tool to control it. Historically, central banks in emerging regions were forced to raise interest rates in crises to try to prevent large currency sell offs. Inflation targeting, improving central bank transparency and other macroeconomic reforms have reduced sensitivity to inflation shocks, including exchange rate depreciations. As a result, many Asian central banks were able to ease monetary policy in 2020.
In Asia, the changing nature of inflation and central banking has even led to some of the Asian government bonds behaving as “safe” assets in the pandemic. For example, Chinese, South Korean and Singaporean benchmark government bonds all had positive returns to sterling investors (unhedged) in March 2020. This isn’t true of all Asian government bonds in portfolios, but our exposure still outperformed the US and Europe (including UK) corporate bond mandates in that period.
Asian bonds are a diverse asset class, so there are exceptions. Not all central banks are independent or able to lower rates in a crisis. Debt levels have increased and despite the development of local currency denominated financial markets, there is significant exposure to external (i.e. denominated in a non-domestic currency) debt.
The underlying manager - Eastspring Investments
- Eastspring have been operating in Asia since 1994
- Eastspring are located in 10 major Asian markets giving them one of the largest footprints in the region
- In a region where corporate cultures are extremely complex and diverse this footprint and experience is very important
- The experienced fixed Income team has a 20-year history of investing in Asian fixed income
- Both portfolio managers have been within Eastspring since 2007
The two main parts to the Asian bond mandate in PruFund are the Eastspring Asia Dollar Bond Fund and the Eastspring Asia Local Currency Bond Fund. However, the portfolio managers are also able to invest in off-benchmark positions in Asian High Yield and China and will look to add performance to the overall portfolio by adjusting the amount invested in each.
The Manager Oversight team within T&IO continue to be impressed with the quality of the individuals in the Asian fixed income team and have high conviction in the strength of the portfolio managers, Guan Yi and Wai Mei.
The team also believe the long-term performance supports this.
|3 year||5 year||10 year|
|SAA Asian bonds benchmark||4.95||4.81||
|Asia bond mandate||5.38||5.24||5.87|
Source: Manager Oversight Team, Treasury and Investment Office, March 2021.
Asian bonds in 2021
LTIS continue to have a favourable view on Asian bonds. They offer higher real returns than developed market bonds and offer diversification potential to portfolios. Although yields have fallen they remain significantly above developed markets.
The table below shows how exposure to Asia has gradually been increased alongside more recent additions like African and Emerging Market bonds. This emphasises the philosophy of looking for sources of future returns across portfolios.
Figure 2: PruFund Growth Fixed Income Allocations
Source: Treasury and Investment Office, May 2021 (data as at end November 2020)
LTIS still feel the risk premium in Asian bonds more than compensates for credit risk. The pandemic has been a strain on government spending everywhere. This may prompt concerns about the credit risk associated with Asian bonds although approximately 75% of PruFunds hard currency Asian benchmark is rated as investment grade.
An important narrative around PruFunds has been the global diversification and ability to adjust portfolios as capital markets evolve. This has often involved adding new asset classes, like Asian bonds.
The journey to being added to a PruFund portfolio can often be a long and complex one. The strategists and economists within LTIS spend a lot of time understanding the nuances of each asset class, the broader economic picture in each country or region, the future potential returns and whether they offer further diversification to portfolios.
Once the asset class has been researched, understood and modelled within portfolios, the search can then start for an underlying fund manager with the appropriate skills, experience, resource and scale to most effectively run the assets. This process can often be lengthy and painstaking as many hundreds of millions of pounds are often allocated to new managers and the aim is to establish a long-term partnership with these managers.
When all this work is completed it is often the case that managers are gradually allocated capital to give them the best chance to implement their investments in a timely and cost-efficient manner.
As we have shown with Asian bonds the whole process can take several years and again re-iterates the huge amount of work that is carried out within PruFund portfolios, from idea generation to validation and then to the implementation.