Asian bonds offer attractive yields despite possible US rate hike

 
   

Asian local currency and US dollar-denominated bonds offer attractive yield to maturities versus 10-year US treasuries, making them good investible assets given expected moderate increases in interest rates this year.

But the key to investing successfully in this asset class under existing market conditions is “selectivity”, according to Ooi Boon Peng, chief investment officer for fixed income of Eastspring Investments.

“2017 could be dictated by tactical needs given that current yield and credit spreads are not offering particularly attractive valuations. Thus, when growth and liquidity fears trigger sell-offs that expose value, we would probably risk up our portfolio,” Ooi says.

Eastspring sees good yield value in many Asian bonds, particularly Singapore local currency government bonds (2.75%), Singapore US dollar bonds (3.7%), Asian corporate investment grade bonds (3.7%), Philippine US dollar bonds (3.7%), Indian US dollar bonds (3.9%), Indonesian US dollar bonds (4.0%), Emerging Asia local currency bonds (4.1%), Philippine local currency bonds (4.2%), Asian corporate high yield bonds (6.0%), and US corporate high yield bonds (6.0%).

These yields are higher than 10-year US treasury bonds, which yield only 2.47% as of February 15. US treasury yields have been gaining in the past two months riding on reports that US Federal Reserve chairwoman Janet Yellen may raise interest rates during the Fed’s coming policy meeting on March 14-15.

“We are looking for opportunities in the higher yielding currencies particularly Indonesian rupiah and Indian rupee. We also looking to take tactical trading opportunities in the US dollar versus Asian currencies, depending on the path of US rate hikes,” says Ooi.

In terms of prospects, Asia offers much stronger economic growth compared to the US and Europe, as well as more stable sovereign credit quality outlooks and clear political reforms.

Asian bond markets also continue to increase in size, offering a breadth of opportunities for value-focused asset managers.

However, fixed income investors in general are still gripped with uncertainty which Ooi refers to as the “wall of worry”, when looking at the overall prospects for the bond markets for the rest of 2017.

“Persistent and somewhat indefinable fears are spooking investors. These fears are compounded by the lackluster aggregate global demand, geopolitical issues and the policy uncertainties surrounding a Trump presidency,” Ooi says.

The general fear among fixed income investors is that in response to the potential rise in the risk-free US interest rates, equity markets and credit spread valuations may decline.

In this type of market environment, returns are expected to be lower and the better returns will be seen at the higher risk end of the spectrum.

“Lower bond yields and narrower credit spreads dictated market conditions as we entered 2017. Yet there seem to be few reasons to be pessimistic, and even fewer reasons to fear the year will end in tears,” Ooi says.

Date

16 Feb 2017

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