|Asian investors have traditionally put a lot of emphasis on the stock market, but the global financial crisis of 2008 and the European debt crisis of the last couple of years have directed portfolios toward greater bond allocations. This trend should continue, and the good news is that the choices for Asian investors are growing right in their own backyard.
For the past several years, Asian bonds have delivered returns comparable to those of equities, but with much lower volatility. Since 2005, the J.P. Morgan Asia Credit Index has brought in an average annual return of 7.5%, while the MSCI Asia ex-Japan equity index has delivered 8.0%.
Compared to their US and European counterparts, Asian governments have lower debt levels and are more prudent with public borrowing. Thus, the bonds issued by these governments and their associated entities have become sought-after assets for Asian investors as well as global investors looking to diversify from their home markets. Asian quasi-sovereign bonds may no longer be particularly cheap at this time, but they deserve a spot in the core holdings of an Asian bond portfolio as they yield more than sovereign bonds without adding too much risk.
Asia’s strong economic fundamentals have also boosted the creditworthiness of many investment-grade conglomerates. As of mid-March, bonds of these issuers yielded an average of 250 basis points over US Treasuries—still decent and with room for further tightening. Yields of ‘BBB’-rated bonds are particularly attractive at over 300 basis points over Treasuries with five to seven years of maturity.
Investors with higher risk-tolerance can look for opportunities in high-yield or non-investment-grade bonds. Asia’s growth has brought more of such issuers to the market as they seek to fund their expansion. The stronger of these credits tend to be those exposed to rising domestic consumption, such as retail, services, utilities and energy companies. There are also a number of Chinese property companies in this segment, but preference should be given to the state-owned or leading national developers rated ‘BB-’ or above. Because many high-yield Asian issuers are novice borrowers and carry corporate-governance risk, investors need to be selective and diversified, potentially using bond-funds to gain exposure.
Local currency bonds are also interesting, especially the Singapore dollar and offshore renminbi or ‘Dim Sum’ bonds. The Singapore dollar has potential to appreciate because it is used as a policy tool to counter domestic inflation, while the offshore renminbi could be a long-term store of value. Recent expectations for the renminbi to appreciate to a lesser extent have also pushed up yields of Dim Sum bonds, providing a more reasonable entry point to these assets. Dim Sum bonds are suitable for investors with a medium-term horizon, and much of the potential gains that should come from the renminbi’s appreciation against the US dollar in the near term should be modest.
With such a range of bond options, Asian investors have a wealth of opportunities to balance their portfolios and achieve decent returns.