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ASIA’S FUNDAMENTALS seem to be so strong that it’ll take a lot to do any lasting damage to its fixed income landscape, especially as investors await the next equity market correction. As trade negotiations between the US and China turn hostile, emerging market investors are selling their equity positions and investing in bonds instead. What’s more, the big shift in Fed policy has created a dovish backdrop for fixed income, and the low expected default rates and attractive valuations are giving Asia that extra edge. Deutsche Bank Wealth Management, for example, is recommending that investors take profits on equities and allocate the cash to bonds instead. Indosuez Wealth Management, meanwhile, likes unconstrained fixed income funds that offer strong downside protection and that complement existing holdings. JPMorgan Private Bank is cautiously constructive on global credit. In the investment grade corporate space, the bank is recommending US credits over European ones. Similarly, J. Safra Sarasin is also keen on spread products such as high yield and investment grade corporates. At the end of 2018, the market for green bonds had reached $334 billion, with China the largest issuer globally. NN Investment Partners is seeing strong demand from European investors for Asian green bonds and is confident that Asian investors will put more emphasis on the impact of their investments. All this and more in this supplement examining the world of fixed income.
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Audrey Raj Editor, Citywire
INTRODUCTION Fund flows data WEALTH MANAGERS Global view Asia ESG Top managers
At $17 trillion and 16% of global securities outstanding, Emerging Market Debt (“EMD”) universe has now become too significant as a source of income and differentiation for global portfolios to be ignored. Yet, with three sub asset classes, with more than 70 countries, 30 currencies and 1000 corporate entities – investors often struggle to make sense of this diversity and struggle with market timing, as well as the management of volatility and occasional liquidity crunches.
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A new way to invest in EMD– beyond hard and local currency paradigm
Our objective is to deliver the income stream and capital gain potential from EMD in a risk-managed way such that it becomes a core allocation in your portfolio. Specifically, we aim to capture the upside for ½ of the volatility and ½ or less of the drawdown.
Using Finisterre’s hedge fund DNA & unique approach, we aim to deliver the income and return stream across the whole EMD universe in a risk-managed way such that it can now become a resilient core allocation in your portfolio. LEGACY APPROACH IS INEFFICIENT Traditionally, EMD allocation has been characterised by benchmarked exposures. About 85% of global EMD mutual fund assets remain benchmarked to either hard currency sovereign, corporate credits, or local currency bond indices. What often ensues is an inconclusive debate as to how and when to allocate between the three to achieve the most optimal results. Benchmarked fund managers typically just follow their benchmarks up and down, trying to slightly outperform along the way as market Beta is imposed by the benchmark. A benchmarked approach is also of very limited use to exploit the potential of an increasingly differentiated universe where dispersion across countries, sectors and issuers returns become the rule. Managers tend to fret over the idea of striding too far from their benchmarks, preventing them to be completely absent from a deteriorating story (e.g. Argentina and Turkey in April 2019). Indices also hide a wide dispersion of situations and returns, linked to the differences in which EM countries need to address changing parameters in the global business cycle (e.g. lower Chinese and commodity demand, technological disruption, changing globalisation patterns etc.). We believe this has translated into a broad range trading environment for indices, with a lot of dispersion along the way. In addition, these broad benchmark categories tend to be a bit artificial. Several corporate index members are state-owned companies or banks. Likewise, while a local currency benchmarked fund is not an optimal strategic holding (in aggregate) given its excessive FX volatility and awful Sharpe ratio over 5, 10 or 15 years, one can still identify low volatility, long-term income opportunities in local currency markets (e.g. Peruvian government bonds, Egyptian T-Bills). INCOME ACCOUNTS FOR BULK OF EMD PERFORMANCE Another important aspect of investing in EMD is that, looking at index returns over the medium to long term, income has accounted for more than 80% of both local and external EM debt returns. Contrary to the common idea that EMD is a Beta-driven asset class, pure price moves mostly brought volatility and little long-term returns over 15 years, unless portfolio exposure was actively managed across different market cycles.
DAMIEN BUCHET CIO Total Return Strategy, Finisterre Capital, majority owned by Principal
EMD INVESTING 2.0 These observations, together with the well understood concern from many investors to limit volatility and the impact of market crises, led us to a new way to invest in EMD. An approach that is completely index agnostic and truly unconstrained. That is grounded on income as the core component of portfolio returns but complemented with tactical capital gains from market timing with liquid “Momentum” assets, and alpha generation from more idiosyncratic assets or relative-value strategies. A process that enables the portfolio to risk
and de-risk quickly thanks to a careful management of liquidity risk. A process that builds on Finisterre’s hedge fund DNA to dynamically manage the portfolio appropriately through different market cycles. TECHNICALS (RISK AND LIQUIDITY) AS IMPORTANT AS FUNDAMENTALS Finisterre Unconstrained EM Fixed Income (“the strategy”) portfolio construction process starts with premise that an EMD portfolio’s “technical” risk profile is key in explaining its behaviour during periods of market stress, often more important than its “fundamental” risk profile. The logic of our portfolio construction process rests on the notion that, across all EMD sub-asset classes, each asset in our investment universe is either a “Cash-proxy”, an “Income” generator, an “Alpha” provider, or a high market sensitivity “Momentum” asset.
¹Hard currency sovereign bonds is represented by the JP Morgan Emerging Market Bond Index Global Diversified, local sovereign currency bonds is represented by the JP Morgan Government Bond Index - Emerging Markets. ²The Blended Index is currently 33.3% CEMBI Broad Diversified, 33.3% EMBI Global Diversified, and 33.3% GBI-EM Global Diversified, gross of withholdings taxes, rebalanced daily. The benchmark was changed retroactively on 30 April 2017 back to 1 June 2013. This change is due to the fact that the current benchmark more accurately reflects the investment strategies of the fund. No leverage cost assumed. Additional information concerning this is available on request. The information in this document contains general information only on investment matters and should not be relied upon nor should it be construed as specific investment advice, an opinion or recommendation. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however we do not independently verify or guarantee its accuracy or validity. All expressions of opinion and predictions provided herein are subject to change without notice. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security. Past performance is not a reliable indicator of future performance. Subject to any contrary provisions of applicable law, no company in the Principal Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions in this document. All figures shown in this document are in U.S. dollars unless otherwise noted. This material is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. This document is issued in: Hong Kong by Principal Global Investors (Hong Kong) Limited, which is regulated by the Securities and Futures Commission and is directed exclusively at professional investors as defined by the Securities and Futures Ordinance; in Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No. 199603735H), which is regulated by the Monetary Authority of Singapore and is directed exclusively at institutional investors as defined by the Securities and Futures Act (Chapter 289). This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.
MATCH PORTFOLIO TO MARKET CYCLES Unlike an index or benchmark focused fund which has the same (or very similar) portfolio 365 days of a year, we believe that the key to capital preservation and capital appreciation in EMD is an understanding of different market cycles and how best to position your portfolio appropriately for each stage of the market cycle as a combination of “Cash-proxy”, ”Income”, “Alpha” and “Momentum”-driven assets or strategies. FINISTERRE UNCONSTRAINED EM FIXED INCOME – EMD INVESTING 2.0 THAT WORKS Success of the strategy is attributable to the repeatable process the team has in assessing both macro & micro factors. The strategy has over the last 6 years delivered on its objective – capturing the upside for ½ of the volatility and ½ or less of the drawdown.
Explore Principal’s risk-managed income solutions. Learn how you can cushion your emerging market income with Finisterre’s unconstrained emerging markets fixed income strategy, please visit our strategy webpage.
Chart 1: average annual income vs. capital gain return since 2003
9%
6%
3%
0%
EM Hard Currency Sovereign¹
EM Local Currency Sovereign¹
Average income
Average Capital Gain
1.60%
6.69%
0.61%
6.63%
Source: JP Morgan, Finisterre Capital. Both graphs as of 31 December 2018.
Chart 2: MATCH PORTFOLIO TO MARKET CYCLES —Cash-proxy / Income / Alpha / Momentum
The above is based upon Finisterre’s current opinions. There is no assurance that such projections will occur and actual conditions may be significantly different than shown here. All expressions of opinion and predictions are subject to change without notice.
-20%
20%
40%
60%
80%
100%
120%
140%
Momentum
Value
Income
Cash proxy
Active Expo
Rally
Correction
Crisis
Chart 3: Upside/downside capture ratios
Past performance is not a reliable indicator of future performance. The example scenarios shown are chosen by Finisterre Capital from other crises during which the Finisterre Composite may or may not have performed comparatively well. Source: Finisterre. Data as of 31 March 2019.
15%
10%
5%
-5%
-10%
Gross Performance (% of NAV)
Downside capture ratio: 59.7%
Downside capture ratio: 22.7%
Downside capture ratio: 47.9%
Downside capture ratio: 22.4%
Upside capture ratio: 85.0%
Upside capture ratio: 103.6%
-3.7%
-6.1%
-1.4%
-6.3%
-2.2%
-4.6%
-1.9%
-8.4%
13.8%
16.2%
15.8%
Taper Tantrum 03/06/2013 - 24/06/2013
Russia crisis 26/11/2014-16/12/2014
U.S. election 08/11/2016 -30/11/2016
FED Normalisation 25/01/2018 - 05/09/2018
Commodity prices recovery 20/01/2016 - 07/11/2016
Post Trump recovery 01/12/2016 - 25/01/2018
Finisterre composite returns
Blended index returns
2
15.3%
FOLLOWING A SERIES of interest rate hikes last year and a sharp bout of market volatility, fixed income funds were battered by cumulative outflows of $49.7 billion in the final quarter of 2018. However, the asset class is poised for a rebound as the Federal Reserve signals a hold on further rate increases. In the first quarter of 2019, investors committed a total of $39.2 billion to the bond market. Global high yield bonds were hit hardest during the bond sell-off last year, but investor confidence has since turned positive. Performance in the global high yield space has also recovered, with
the average fund in the sector improving from a loss of 4.2% in the fourth quarter of 2018 to a 5.8% gain the following quarter. While both the global bond and global flexible bond sectors also experienced a turnaround in asset flows, it should be noted that a large proportion of the new subscriptions have gone to a handful of top-selling funds in the respective sectors. The first quarter of this year also marked the end of a dry spell for the Pimco GIS Income fund. The blockbuster fund had netted inflows of $46.2 billion over the course of 2017, which sent its assets soaring to $72.4 billion by the end of that year. However, it was subsequently hit by a string of outflows from February to December 2018, before finally reclaiming its place as one of the fastest-growing funds. ♦
Celeste Goh reveals the bright spots in fixed income and the sectors enjoying a fresh start to the year
Earlier this year, Nick Maroutsos, Co-head of Global Bonds, took control of the Janus Henderson Absolute Return Income Opportunities portfolio. It had recently changed its name to better reflect a more involved investment style suited to the interconnected but complex conditions that fixed income investors face today, while also shifting from a manager-centric to a more team-led approach. The team itself reflects the capabilities of Kapstream Capital, the absolute return fixed income specialist acquired by Janus Henderson in 2015.
What If The Federal Reserve Cuts Interest Rates?
Investors need an agile and unconstrained approach to tackle global fixed income volatility, says Nick Maroutsos.
The strategy retains the same objective: it seeks to maximise total return and preserve capital in all market conditions. The team looks to provide an absolute return profile with moderate volatility and a focus on downside protection. The investment process remains unconstrained by benchmark considerations. It also has significant latitude to pursue opportunities across the fixed income spectrum, including moving between sectors, across credit risk and adjusting duration. The team made use of this agility in the recent bouts of volatility. The portfolio has two elements. The core includes assets such as government bonds, corporate bonds and mortgage-backed securities to provide a source of income. It also has an alpha component. ‘We focus on high quality assets, helping to provide greater stability of income for the end investor. We invest globally, including in emerging markets, although the primary focus is on developed markets. That global diversification can help lower the overall volatility of the portfolio,’ Maroutsos says.
NICK MAROUTSOS Co-Head of Global Bonds Janus Henderson Investors
DISCLAIMER The content herein is produced for information, illustration or discussion purposes only and does not constitute an advertisement or investment advice or an offer to sell, buy or a recommendation for securities in any jurisdiction and do not purport to represent or warrant the outcome of any investment strategy, program or product, other than pursuant to an agreement in compliance with applicable laws, rules and regulations. Not all products or services are available in all jurisdictions. Investment involves risk. Past performance cannot guarantee future results. Janus Henderson Investors is not responsible for any unlawful distribution of this document to any third parties, in whole or in part, or for information reconstructed from this document and do not make any warranties with regards to the results obtained from its use. It is not intended to indicate or imply that current or past results are indicative of future profitability or expectations. In preparing this document, Janus Henderson Investors has reasonable belief to rely upon the accuracy and completeness of all information available from public sources. Unless otherwise indicated, the source for all data is Janus Henderson Investors.This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission. Anything non-factual in nature is an opinion of the author(s), and opinions are meant as an illustration of broader themes, are not an indication of trading intent, and are subject to change at any time due to changes in market or economic conditions. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio. No forecasts can be guaranteed and there is no guarantee that the information supplied is complete or timely, nor are there any warranties with regard to the results obtained from its use. The information contained is only available to investors in targeted jurisdiction. Note to Singapore Readers: Issued in Singapore by Janus Henderson Investors (Singapore) Limited, licensed and regulated by the Monetary Authority of Singapore. Company Registration No. 199700782N. This advertisement has not been reviewed by the Monetary Authority of Singapore. Note to Hong Kong Readers: Issued in Hong Kong by Janus Henderson Investors Hong Kong Limited, licensed and regulated by the Securities and Futures Commission (“SFC”). This document has not been reviewed by the SFC. Janus Henderson is a trademark of Janus Henderson Group plc or one of its subsidiary entities. © Janus Henderson Group plc. For professional investors use only. Not for public viewing or distribution. KH0519(56)0819.HK.PI
‘We believe the Fed’s next move will be down’
CHANGING ENVIRONMENTS Maroutsos believes the bond market backdrop has changed significantly since last autumn. The threat of tightening interest rates has receded but investors should not expect volatility to disappear as a result. Fixed income investors and their fund managers must be flexible and agile as other issues come to the fore. ‘We face an extended credit cycle, weaker corporate profitability and myriad geopolitical risk,’ says Maroutsos. Globally, real yields have potentially reset at higher levels and could stoke more volatility as they did last year. But those real yields are back below 1% in the US and remain negative across much of the developed world, so investors still face a challenge to generate the income they need at levels of risk they can bear. ‘Fixed income strategies must work harder to find risk-adjusted return opportunities. This challenge is most acute within core bond strategies, especially in regions where benchmark rates hover near zero,’ warns Maroutsos. LONGER NOT ALWAYS BETTER Last year, the market worried about wage growth stoking inflation in the US. That inflation failed to materialise and 10-year US Treasury yields have dropped as a result. This coupled with slower global growth and trade war fears have led many to believe that the Fed will adopt a more dovish stance for the foreseeable future. ‘We are not alone in expecting the Fed’s next move to be a rate cut. The European Central Bank’s recent decision to introduce a new round of loans to financial institutions further illustrates a re-emerging dovish bias to central bank thinking,’ says Maroutsos. In such a scenario, Maroutsos and his team see no reason to increase exposure to long-dated bonds, especially given the current US Treasuries yield curve is at its flattest since the global finance crisis. The recent inversion means that US Treasury bills up to 1-year in maturity yield more than many longer-dated notes, but with lower duration risk. ‘We believe the Fed’s next move will be down, albeit in 2020. Under a backdrop of lower rates and continued US economic expansion, bond investors should favour the front end of the US yield curve and look globally to meet their objectives,’ says Maroutsos. Lower rates favour risk assets but limit the opportunity for capital appreciation on longer-dated bonds. Shorter-duration securities, on the other hand, present the best chance for gains, given that Maroutsos expects the yield curve to steepen as policy rates eventually fall. ‘For income-seeking investors, we do not believe the marginal gain in carry justifies the additional interest-rate risk undertaken with longer-dated bonds,’ he says. Other central banks can use the Fed’s pivot to continue or increase their accommodative policies. For countries reliant upon global trade or commodities, slowing growth makes rate cuts all the more likely. ‘We also consider foreign-domiciled investment-grade issuers to be attractive sources of carry, given their relative yields, strong competitive positions, and in some cases, implicit government backing,’ says Maroutsos.
A DISCERNING EYE A selective approach is required, nonetheless. US corporates have relatively high debt levels and Europe is flirting with recession, meaning many bond issuers may struggle to meet coupon or redemption commitments. Countries and issuers that may be caught in the crossfire in the trade dispute between China and the US should also be avoided. ‘Developing regions often encompass robust secular themes such as the growth of banking in emerging Asia and infrastructure spending, often with government banking, more widely. An unconstrained approach allows investors to avoid, rather than just underweight, segments, sector or regional elements of a benchmark that may be structurally challenged,’ says Maroutsos. APPROACH WITH CARE In a fast-changing and volatile world, investors should remind themselves that capital preservation is no sure thing. Market liquidity remains the biggest concern for Maroutsos and team. ‘While late 2018 may have caught investors’ attention, the post-crisis market-clearing infrastructure has yet to be truly tested. Given the array of risks in the marketplace, any number of scenarios could lead to a liquidity event in which price dislocations are pronounced,’ says Maroutsos. He suggests investors remain on high alert for signs of potential market stress, keeping a close eye on traditional metrics such as interest rate volatility, credit default swap pricing and foreign currency movements. The latter takes on elevated importance as exposure to foreign currency-denominated securities increases. Those metrics may give investors the advanced notice needed to dampen portfolio volatility, but portfolio construction may also further the cause. In an environment of low growth and high debt, and with central banks remaining a swing factor, a globally diversified portfolio can help moderate volatility by targeting maturities, regions and issuers with the most attractive risk-adjusted return profiles. It can also avoid those where the risk asymmetry is too great, concludes Maroutsos.
For more information on Janus Henderson's fixed income capabilities, please visit www.janushenderson.com
WHILE THE GENERAL sentiment towards fixed income has improved, not all sectors have benefited from this. The chart on the right reveals the sectors that have suffered from a negative turn in flows or an exacerbation of outflows in the first quarter of this year.
Celeste Goh unveils the fixed income funds and sectors that continue to be shunned by investors
While the global US dollar hedged bond, US dollar short-term bond and global short-term bond sectors bucked the trend with net inflows amid the volatility of the fourth quarter of 2018, enthusiasm for these categories proved short-lived. In particular, investors’ interest in short-duration bond funds has notably faded as central banks turn dovish. Within the global US dollar hedged bond sector, the M&G (Lux) Global Floating Rate High Yield Bond fund experienced the largest redemptions in the first quarter of 2019. The fund was only launched in September last year and had in fact amassed $3.3 billion over the closing four months of 2018. However, the inflows that it experienced in December last year were partly the product of a transfer of assets from its UK-authorised equivalent fund. ♦
As investors navigate what could be the twilight hours of an elongated credit cycle, an increase in defaults is not only possible, but probable. Against this backdrop, a credit-intensive, global approach to high yield investing is key. While the pendulum of sentiment has swung from one extreme to another, seasoned investors who have followed the market through multiple credit cycles and downturns have made the
Four Reasons Security Matters Right Now
Why global senior secured bonds may be an attractive way to invest in high yield late in the cycle
observation: For those willing to surrender a nominal amount of yield, in favor of a higher seat in the capital structure given a default, global senior secured bonds—a lesser known and perhaps underappreciated subset of high yield—can be an attractive option. Martin Horne, Barings’ Head of Global High Yield, discusses four reasons why. CAPITAL STRUCTURE SENIORITY Defaults have remained near historical lows in recent years, but inevitably they will begin to rise when the credit cycle ultimately turns. In such an environment, being senior in the capital structure will be critically important. Senior secured bonds, as their name indicates, sit at the top of the capital structure alongside senior secured loans. In the event that a corporation defaults on its debt obligation to investors, and therefore fails to repay the bond it issued, it can be forced into bankruptcy liquidation. In such a case, its assets are sold off to repay its debts, which are repaid in a prescribed order of priority—with senior debt first, ahead of junior/subordinated debt. If a bond is classified as secured versus unsecured, it is backed by issuer collateral and has capital structure seniority, thereby placing it at the top of the repayment order.
MARTIN HORNE Head of Global High Yield Investments Barings
Important Information This document is intended for institutional investors/professional investors only. The document is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This document is not, and must not be treated as, investment advice, investment recommendations, or investment research. In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved and before making any investment decision, it is recommended that prospective investors seek independent investment, legal, tax, accounting or other professional advice as appropriate. Unless otherwise mentioned, the views contained in this document are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Parts of this document may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this document is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information. Investment involves risks. Past performance is not a guide to future performance. Investors should not only base on this document alone to make investment decision.
Collateral can take the form of various assets—including real estate, equipment, vehicles, and intangible items like software or trademarks—and lenders may be offered different security packages by buying into a specific claim or lien over the collateral. Such collateral may then be used to satisfy any outstanding claims by the senior secured lenders. Secured lenders are effectively the most preferred creditors in a company’s capital structure, having first call on a particular pool of assets ahead of even the most senior unsecured lenders. HIGHER RECOVERY RATES Because senior secured bonds are the first to get paid out in the capital structure, and due to their backing by hard assets, in the event that a company defaults, they tend to have a higher recovery rate than traditional unsecured high yield bonds—meaning a greater proportion of the debt is repaid. Based on the debt and equity cushion beneath the instruments, the senior secured bonds tend to be covered by twice the value when first issued. This generally tends to lead to a higher recovery rate, compared to the broader
high yield bond markets. Historically—although weighted toward retail and commodity defaults, which are areas of traditionally lower recovery—during the period from 1987–2019 (YTD) the average recovery rate for defaulted senior secured bonds was 62.1%.¹ Though the rate of recovery depends on a number of factors—including the nature of the collateral assets, the current market for them, and the legal and practical steps involved in recouping the principal assets—secured lenders will always have a seat at the table in negotiations regarding a restructuring, and will be treated as senior throughout the process. Particularly amid a maturing credit cycle, this priority standing can be attractive to investors who may be wary of investing in a sub-investment grade asset class. A BROAD AND GROWING OPPORTUNITY SET Another valuable consideration for debt investors is the sheer size of the opportunity set, as well as its historically low correlations with other asset classes—which offer the additional benefit of diversification. The senior secured high yield bond market has experienced substantial growth since the global financial crisis (GFC), particularly in Europe. This is due largely to the emergence of the asset class as a viable source of funding for companies, whereas other capital-raising avenues—including loans and unsecured bonds—have faced limitations as banks pared lending during and after the GFC. Today, the value of the market is in excess of US$315 billion.² CONSISTENT RETURNS THROUGH THE HEADLINES Senior secured bond returns have been compelling on a historical basis—having delivered average returns of approximately 7.0% per annum over the last 15 years.³ It is worth noting that such returns were generated through several periods of geopolitical uncertainty—including the GFC, the sovereign debt crisis, the “Taper Tantrum,” the commodity cycle, and Brexit, to name a few. So, particularly in the event of broader market weakness—for investors willing to give up a minor amount of spread, and withstand some short-term volatility—senior secured bonds can offer a degree of principal protection that unsecured bonds cannot, while still generating an attractive return. IN CONCLUSION The outlook for high yield markets remains reasonably positive based on the underlying fundamentals of issuers. But inevitably, the cycle will turn and defaults will rise. When this happens, senior secured bonds are an asset class that can provide investors continued exposure to high yield, but with some additional lines of defense.
¹Source: Moody’s Corporate Default & Recovery Rates. As of 31 March 2019. ²Source: Bank of America Merrill Lynch. As of 31 March 2019. ³Sources: Barclays, Bank of America Merrill Lynch, Credit Suisse. As of 31 March 2019.
Asia’s private bankers are navigating the low yield environment with a degree of caution ahead of a potential downturn, Neil Johnson finds
© Photo by Ryan Tang on Unsplash
PERHAPS UNSURPRISINGLY – particularly given the rollercoaster ride that capital markets have been on since the end of 2018 – the mood among private bank fund selectors right now could best be described as a pinch of optimism mixed with a dash of dubiousness. Or as Pierre DeGagné, head of funds selection at DBS Private Bank, puts it: ‘Constructive, but cautious.’ BlackRock CEO Larry Fink recently claimed that we’re in ‘a Goldilocks moment, where it’s not so bad but it’s not so good. Central banks’ behaviours are probably on the dovish side. I would say it’s time for investors to be a little bit more relaxed.’ Indeed, the early months of 2019 have been defined by better-than-expected earnings in anticipation of a US-China trade deal, a relatively stable US dollar and steadier growth in China. The Goldilocks situation of low but positive growth (not too hot, not too cold) pushed asset volatility to record low levels. Risk assets responded in kind, and global credit markets rebounded confidently. The correction forced valuations to the cheap side, especially in high yield, setting the stage for a strong performance in the first quarter as a whole. US high yield enjoyed its strongest first quarter on record, returning 7.27%, while Asian high yield returned 7.84%. And inflows did seem to suggest that investors had decided it was time to be a little more relaxed. Flows into emerging markets and Asian bond funds in particular are healthy and may continue to be boosted by China’s onshore investors and regional private banks. HELLO AGAIN, VOLATILITY But the calm was disrupted in May as geopolitical tensions resurfaced between China and the US. President Trump slapped fresh tariffs on Chinese goods, and the row over Huawei continues to roll on. ‘The recent developments are a reminder that one should not get too complacent and that there is potential for bouts of volatility in this late cycle,’ said Ajeet Choudhary, executive director for fixed income, FX and commodities at JP Morgan Private Bank in Asia.
‘The recent developments are a reminder that one should not get too complacent and that there is potential for bouts of volatility in this late cycle’
Ajeet Choudhary JP Morgan Private Bank
Mandy Lui Barings
‘As market volatility surges, downside protection and diversification become increasingly important’
Choudhary is cautiously constructive on global credit. Despite the uncertainty, fundamentals remain in place, and he advised keeping some dry powder to exploit the opportunities created during periods of volatility. In this scenario, he advocated a balanced barbell strategy, with carry as the main driver of returns for the rest of the year. Opting for long duration and moving up in quality should help to ensure that fixed income allocations will outperform cash. However, it might not be plain sailing, as he noted that macro risks are not evenly distributed globally. ‘We believe that downside economic risks are more pronounced for the euro area. In the investment grade corporate space, our preference is for US credits over European ones.’ PLAY IT PATIENTLY Meanwhile, DeGagné’s outlook prescribes a ‘patient’ barbell approach. ‘Firstly, concentrate on the core, which should include funds that are all-weather and of lower volatility,’ he said. ‘Reduce exposure to the mediocre and apply some exposure to growth positions.’ For this, he favoured the technology and health-science sectors, as well as environmental innovation funds.
‘Finally, the critical piece is the offsetting barbell: tail hedges,’ he said. ‘Here, we like hedge funds – equity long/short and macro-style funds – as well as gold and silver.’ This strategy requires staying in the markets with a bias towards high quality fund managers that can tactically move across global markets, credit quality and duration. ‘The Jupiter Dynamic Bond and Pimco Income funds remain core recommendations, and we prefer these to more regional investment grade and tightly trading Asian bond funds,’ DeGagné said. ‘We see opportunities in Asian high yield. While much riskier, it has spreads that seem fairly priced for the risks. In contrast, other high yield markets appear to be at less attractive spreads for the risks. We would rotate to more global mandates such as the Oaktree Global Credit Opportunities fund.’ MARGIN OF ERROR Adam Mika, a senior fixed income fund analyst at J. Safra Sarasin, is also positive about fixed income, with the Fed’s dovish stance proving a key factor. ‘The Fed’s balance sheet reduction is off the table for the time being. Most importantly, inflation is not an issue and the Fed may tolerate some higher inflation levels without raising rates,’ he said. Echoing DeGagné and Choudhary, Mika felt that this is a good environment for spread products such as high yield and investment grade corporates, but he preferred Europe over the US for overseas investors, as the yield on a hedged basis is high in Europe. ‘Asian clients have always favoured fixed income over equities,’ he said. ‘In this space, clients continue to hunt for yield, generally preferring funds that have stable net asset value and high pay-outs of more than 4% per annum.’ Given this low yield environment, there is almost no room for error in fixed income, which makes manager selection something of a fine art. ‘A mistake can be very costly. It could be a wrong FX call or a detracting position on the yield curve,’ Mika said. ‘However, active management with high conviction bets is important in such a low yield environment. It follows that it is a challenge to find managers who can bridge both: the right bets on the one hand and a well-diversified and liquid portfolio on the other.’ EASY DOES IT Arjan de Boer, head of markets, investments and structuring for Asia at Indosuez Wealth Management, described this low yielding Goldilocks scenario as ‘a mild risk-off environment’. He is recommending unconstrained fixed income funds that offer strong downside protection and that complement his clients’ existing fixed income holdings. ‘The goal is to assist clients in diversifying the concentration risk in terms of investment positioning,’ he said.
In Asia, de Boer likes China investment grade for its relatively good value in a global context, especially senior corporate perpetual bonds. To tap this, Indosuez is launching a fixed maturity product in Asia, with a focus on an investment grade fund with a competitive yield distribution. ‘In addition to a strong investment team and a disciplined investment process, we put a lot of emphasis on a robust risk control mechanism for this fund, as avoiding default is key for buy-and-hold investment funds,’ he said.
Meanwhile, Mandy Lui, head of wealth and retail distribution for Greater China & Southeast Asia at Barings, has her eye on senior secured assets as a good bet in the later stages of this prolonged credit cycle. ‘As market volatility surges, downside protection and diversification become increasingly important,’ she said. ‘We are seeing strong interest in senior secured assets, and we expect fixed income with a lower risk profile – but that still offers attractive yield – to be appealing to investors. ‘While senior secured bonds and loans are not recession-proof, they are higher in the capital structure than unsecured bonds and can offer investors greater protection from principal loss in the event that market default rates rise. This means that in the event of default, senior secured bondholders are positioned alongside loan investors for a potential recovery. Since senior secured bonds are backed by asset security, these bonds have a lower risk profile.’ ♦
asian high yield returned 7.84% in the first quarter of 2019
trader and author nassim nicholas taleb gained as much as 115% using barbell strategies during the financial crisis
economist david shulman is widely considered to have coined the phrase ‘goldilocks economy’
by 2025, asia’s millionaires are expected to own $42 trillion in assets
in 2019, 55 billionaires were created in china, compared with 53 in the us
Just four decades after Deng Xiaoping opened the Communist country up to rest of the world, China has grown rapidly to become the world’s second largest economy. It’s by far the world’s leading trading nation, lifting the fortunes of those in its ever-expanding orbit. Since the financial crisis in 2008, it’s also acted as the major growth engine of the world, providing a much-needed stimulus as developed states grapple with growing debt and declining demographics and struggle to reflate their economies. What does all this mean for fixed income investors? As investors and policymakers alike begin to turn their attention eastward, the region has become impossible to ignore. One strategy that’s been taking advantage of these changes is the DWS Asian Fixed Income strategy, managed by Citywire AAA-rated and Hong Kong based manager, Henry Wong.
INCOME IN THE EAST: ASIAN HARD CURRENCY CORPORATE BONDS
HARD CURRENCY CORPORATES? Investing almost solely in hard currency Asian corporate bonds, the veteran manager, who joined the firm in 2014 to oversee its Asian fixed income operations, is quick to point out how the Asian debt markets have evolved in recent years – and the opportunities that have arisen as a result. ‘While there has been a lot of focus on the troubles of emerging market debt of late, the Asian hard currency market has actually traded more like a developed market’ he explained. ‘This underlines the evolution that’s been taking place over the years; volatility has been coming down, issuance has increased, the market has matured, and risk-adjusted returns have steadily improved as a result.’ Much of this reflects the changing nature of Asia itself. As local investors accumulate more wealth, issuers are encouraged to sell dollar bonds, which have proved a major hit among local pension funds, insurance firms, and fund houses. ‘There are huge changes afoot that investors should be aware of,’ Wong added. ‘In the last five years, more than three-quarters of the new dollar issuance has fallen into the hands of domestic investors looking for long-term returns.’ He continued: ‘They don’t mind holding that duration. This has had an enormous effect. Suddenly the market is anchored toward fundamentals and the strength of companies, rather than hot money portfolio flows and carry trade tourists. That suits our style.’ TAILWINDS & HEADWINDS With treasury yields falling dramatically and central banks seemingly becoming dovish once more, domestic demand for income should prove crucial in the months ahead. ‘We’ve seen in other regions how quickly those flows can unwind,’ Wong cautioned. ‘But Asian investors have shown a keen appetite for US dollar bonds sold in the region, buying a record amount in recent years.’ What about the ongoing trade dispute that has rattled Asian markets over the past year? How is Wong positioning his portfolio for this? ‘It’s understandable that people are concerned about a trade dispute,’ he admitted. ‘No one likes these sort of trade tensions. Any negative news is a headwind, and tariffs become more of a worry as global growth begins to slow.’ But, he added, ‘this is a simply reality of life. China can no longer have that sort of trade surplus, especially as it aims to rebalance its economy and become more sustainable in the long run. We’ve seen Asian credit consolidate this year after a strong rebound in January and February, but we’re still cautious because of the trade dispute.’ THE OPPORTUNITY SET Fortunately, Wong has been able to foresee many of these major moves that have caught other manager’s off-guard. ‘Even without the trade war, which we’ve been watching very closely, we saw that China’s economy was undergoing a profound shift. So we avoided export sensitive names and began focusing on the rise of the consumer class, which is a much bigger opportunity long-term.’ The Asian fixed income specialist revealed that he’s implemented this consumer and middle class focus across the entire portfolio, as well as the specialist China funds he runs, which has helped insulate his performance from trade tensions and larger macro shocks. In the past year, for instance, Wong’s Asian Bond strategy has delivered a 1Y rolling return of 7.05% as of 31 May 2019. Though the last year proved more challenging, he managed risk carefully after clocking strong returns in the three years before, which saw the AAA-rated manager become one of best Asian hard currency managers, with a number 1 ranking for over three years in Citywire’s Asian bond rankings (Source: Citywire Discovery, as at 31 May 2019). And while the strategy is comprised mostly of BB-rated bonds, Wong believes that the benefits of that rotation into consumption and the so-called New Economy, is only now being realised. Indonesia, one of the leaders in this regard, makes the largest part of Wong’s portfolio, with the manager adding further to the market in recent months. Whilst the fund talks account of macro developments the focus is very much on bottom-up security selection. To that end, Wong thinks that Indonesia is fertile terrain for individual security selection in sectors like Metals and Mining, as well as in certain Property issuers. India, Korea, Australia, and Japan remain other key holdings by country, while Wong also holds long-dated Treasury bonds – a strong performing asset lately – that act as a hedge to any emerging market wobbles or growth slowdowns. IMPROVING FUNDAMENTALS Looking ahead, Wong, who has over 30-years’ experience in banking and asset management, said it’s fast becoming evident that the quality – not quantity – of growth is being prioritised by policymakers and governments in Asia. That won’t be easy; for China, for instance, but it bodes well for the future. ‘This may be painful at times,’ Wong added, ‘but it’s actually a very good thing. It will take a while, but China and Asia as a whole need to shift from their export orientation to domestic consumption. That will bring a lot of trouble to those old industries, but it will create a lot of investment opportunities to the New Economy sectors as well, and that’s what we’re looking toward.’ And with valuations elsewhere stretched following years of quantitative easing (many government bonds have negative yields), a long-term allocation to emerging market debt – and Asian debt in particular – would seem to make sense. And few managers are as qualified as Wong to deliver. His Asian Bonds strategy has been the best performing Asia Pacific Hard Currency strategy tracked by Citywire in the past three years (out of 60 strategies in total). Such has been the take up from investors in the region– since the beginning of the year, the strategy has now more than doubled in size to reach USD 1 billion. With trade tensions rising investors have increasingly sought out Asian Credit portfolios with the flexibility to navigate a more uncertain market environment and lock-in year to date gains in Asian credit markets. ‘A big change is coming,’ he added. ‘Some of this is good, some of it is bad, but as long as we stick to our bottom-up approach and focus on those companies that are positioned to do well in the coming years, then I’m sure we can minimise those external disturbances and continue to do well.’
HENRY WONG Managing Director Head of Asian Fixed Income, APAC DWS
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The markets have been volatile, but asset managers are finding that a series of fundamental factors are supporting the global fixed income space, Neil Johnson reports
© Photo by Thao Le Hoang on Unsplash
THE TOPSY-TURVY global markets have been through a lot lately. The correction in late 2018, the relative glow of a rebound in early 2019 and the threats of a fresh reversal in May have been a tough play for some investors, but for fixed income, the ride has been a little less dramatic. There are several key reasons for this, including a more dovish Federal Reserve. ‘The Fed’s pivot towards a more accommodative stance has created a conducive backdrop for yield products,’ said Wilfred Wee, an emerging market fixed income portfolio manager at Investec Asset Management. ‘Flows wise, there has been a general rotation out of equities into bonds, especially into developed market credit.’ As long as inflation remains muted, the support for fixed income should continue, Wee added. However, at this juncture, he thinks that credit markets are priced richly and are not quite pricing in the full potential for a further deterioration in relations between the US and China. Meanwhile, Scott Thiel, chief fixed income strategist at the BlackRock Investment Institute, argued that the US economy can remain in this late-cycle phase, avoiding recession throughout 2019. ‘A resurgence of recession fears or inflation pressures that may force the Fed to resume tightening pose a risk to our outlook, although there is little sign of economic overheating or inflationary pressures.’ AT THE PUSH OF A BUTTON... Of course, the tense and unpredictable US/China trade war could change all that. Markets can flip with a single tweet from US President Donald Trump, as they did in May, just when the world was starting to think that a thaw was coming in the diplomatic chill between the global giants. ‘The biggest challenge is whether rationality can prevail for a deal to be made,’ Wee said. ‘It’s not in China’s interest to pick a fight with the US, but if pushed into a corner, China will have to stand up strongly. This time around, I think there is a lot of sympathy for China’s stance. The ratcheting up of words has hurt the trust between these two superpowers, so even if there were to be a deal, markets may be sceptical of how long it would last. ‘In the meantime, there will be collateral damage to Asian regional growth and investment plans – the proverbial “animal spirits” – and we might be looking at even softer growth for the rest of this year. These risks mean that high quality fixed income will continue to find a bid. Default rates may pick up in time, and it is key to be highly selective in high yield.’ Indeed, bond yields are higher across global fixed income markets versus two years ago, offering greater income potential. ‘We see a narrow path ahead for risk assets to move higher – but there are risks that could knock markets off track,’ Thiel warned.
‘As active managers, we don’t find developed markets particularly interesting’
Paul Griffiths First State Investments
SOVEREIGN STRUGGLES Paul Griffiths, chief investment officer for fixed income and multi-asset solutions at First State Investments, is particularly interested in the current narrowing spread story, especially in high yield, where he’s turning defensive. ‘High yield has come a long way, and while we think it’s attractive in a relative sense, in an absolute sense there’s scope for a bit of a correction to enable us to take advantage of that,’ he said. Griffiths noted that against the backdrop of emerging markets, the sheer weight of the money in developed markets, with their negative yields, means that most major sovereign bonds are simply unattractive. ‘Obviously we still own them, but at the moment it’s hard to see how we’ll move away from a sustained, continued low rate world,’ he said. ‘From a bond market perspective, given the level of growth that we’re seeing in the developed world (the US aside) and also politically, we think it’s highly unlikely we’re going to see a substantial change any time soon.’ Another view is that income, or carry, will reassert itself as the key driver of bond market returns, taking back the reins from price appreciation, Thiel said. ‘The Fed’s strong reiteration of patience at its May policy meeting has reinforced our view that carry is king. A dovish tilt by other central banks and a slowing but still growing global economy support this view.’
the fed has raised interest rates nine times since 2015
the global bond market is worth more than $100 trillion
the us bond market is worth more than $40 trillion
china’s bond market is the 3rd largest at $13 trillion
emerging market high yield bonds account for 23% of global high yield
Echoing Griffiths’ doubts about sovereigns, Pieter Jansen, senior strategist multi-asset at NN Investment Partners, noted that worries around global growth, dovish central banks and heightened political risks have all pushed safe government bond yields down significantly since the beginning of the year. ‘Government bond yields have stabilised somewhat and continue to be well supported,’ he said. ‘In general, the search-for-yield environment is supportive for fixed income spread assets, with spread levels already falling back to the levels of last summer. But safe government bond yields will likely stay low, as the current macroeconomic environment will keep them there. This will sustain the search-for-yield theme for as long as the global economy does not slide into a more meaningful slowdown with rising default rates.’ EMERGING FROM THE ASHES While this may paint a picture of moderately fertile ground for fixed income investors, safe government bonds are not piquing Griffiths’ interest. ‘As active managers, we don’t find developed markets particularly interesting.’ Where First State does have exposure and where Griffiths thinks the real opportunities lie are in the emerging world, with Asia topping the list. ‘It has been interesting to see how emerging markets have clearly been under pressure because of the stronger rate profile, the stronger dollar and of course growth in the US. ‘They have certainly been able to rally as the perception of a change in stance by the Fed has been taken on board by the markets. In general, we remain positive on emerging market debt and the opportunity for emerging market bonds to rally. ‘We think there’s a natural bid for positive yielding bond markets that have good fundamentals, so what’s happening in Europe, where we’d kill for a US Treasury’s 2% yield, is a supportive bias for emerging markets.’ ♦
Arthur Lau, head of Asia ex-Japan fixed income at PineBridge, wants to bury the lingering myth that Asian bonds are high-risk and too vulnerable to the harsh reality of global investment markets. In recent years, the Asian bond market has proven that it is more resilient than many of its developed market peers.
Asian Bonds: Resilience in the Face of Volatility
Global fixed income investors are finally realising what local bond investors already know, says Arthur Lau at PineBridge.
Over the last five years, volatility-adjusted returns as measured by the Sharpe ratio demonstrate that Asian bonds performed very well compared to other major global asset classes. Domestic investors recognise this, and many international investors are beginning to take note of the benefits, says Lau. Today, Asian buyers make up 78% of the market, which helps to anchor the market and shelter it from fickle “tourist” investors. Asian investors also tend to have a home bias, purchasing issuers they understand and know. ‘It highlights the fact that the Asian bond market is actually not a high yield market, with high beta and high volatility. This market is highly institutionalised, mature and more stable than many others,’ says Lau. Although a high-issuance market on a net basis, the Asian credit market remains stable. Most issuers are investment grade, with widespread systematic government support. Lau believes resilience stems from their healthy financial profile. ‘Asian issuers have very low gearing and high interest coverage ratios compared to peers in emerging markets and even some of the developed markets,’ he says. Those characteristics have also offered a protective element through the many major macro events in the last five years. With a lower duration profile, Asian bonds can be a more defensive play for investors concerned about interest rate risk. As Lau points out, there have been no defaults in Asian investment grade bond universe since the crisis of 1997.
ARTHUR LAU Co-head of EM Fixed Income, Head of Asia ex Japan Fixed Income PineBridge Investments
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‘When market volatility occurs, the Asian bond market becomes the safe haven and continues to attract long-term institutional investors in this region,’ he says. Even so, most international investors still lack exposure to Asia as global benchmark rules favour developed countries. The inclusion of yuan-denominated bonds in the Bloomberg index in April marked a significant development, says Lau, making the yuan the fourth-largest currency component of the benchmark. TRADE WAR IMPACT Although the US-China trade dispute continues to drag on, the direct impact on Asian bond issuers is very limited as they focus mainly on the domestic market and are not directly affected by the tariff. Pinebridge estimates less than 2% of the bonds are from issuers with direct revenue to the US. These include mainly tech companies. Lau thinks the fundamental impact on Asian credit will mainly come via the second order impact of slower economic growth. This has varying implications depending on the area of the market. Investment-grade corporates have been maintaining strong credit profiles over the cycle and should be able to withstand a potential economic slowdown. In high yield, he notes that the Chinese government will support the property sector given its importance to the economy. Large developers are expected to remain resilient and benefit from potential easing. PROACTIVE POSITIONING Lau believes strategies with higher beta will benefit in the near term. Nevertheless, supply risk and potential continued weakening in economic activities globally may affect overall risk sentiment. The evolving trade environment may also impact different sectors in positive or negative ways. ‘We believe volatility will remain elevated and, therefore, positions will need reviewing more proactively and aggressively this year,’ says Lau. ‘We advocate for a modest dialing back of risk in each segment, reducing high beta exposures and incrementally lowering duration risk profiles, particularly in developed markets outside the US, as well as focusing on higher quality credits within segments,’ he adds. As global interest rates normalise, investors should focus more on credit differentiation between sectors, companies and jurisdictions. Sectors like infrastructure will likely benefit from policy support in Asia with countries like India likely to continue on infrastructure development programmes, while sectors like commodities may be subject to some headwind. Countries with higher exposure to autos and IT may face tough conditions as demand weakens. The team is repositioning some investment grade exposures as earnings risks have risen, particularly among some internet and IT-focused firms. Even so, Lau does not expect to see significant credit defaults. ‘I believe there may not be a clear winner for the full year 2019. At the moment, we think there are more opportunities in Indonesia given a more stable economic backdrop comparing to last year and the uncertainty surrounding the election has subsided,’ he says. Lau expects Asian investment grade total returns this year to range between 3% and 4% as credit spreads are already tight and subject to US interest rate movements. In high yield, investors could see returns range between 7% and 8% as carry is already on the high side; but this could come with a higher degree of volatility. He believes an issuer-by-issuer approach to Asian bonds can drive long-term performance—isolating high-quality opportunities that others may miss out by just following the benchmarks and allowing investors to avoid taking on excessive risks.
‘This market is highly institutionalised, mature and more stable than many others’
Strong fundamentals are all well and good, but you’ve still got to land the right punch, fund managers tell Neil Johnson
CUT THROUGH ALL the noise, the headlines, the melodrama, the geopolitical posturing and the spooked markets, and you’ll notice an unerring belief among fixed income fund managers: Asia’s fundamentals are so strong that it’ll take a lot more than a few tweets to do any lasting damage. Indeed, this year is a distinctly different environment to 2018, according to Ross Dilkes, an executive director and portfolio manager for Asian credit at UBS Global Asset Management. ‘The big shift in Fed policy has created a dovish backdrop for fixed income. China has also been stabilising, supporting the economy over the past six to 12 months from where it was in the early part of 2018 and 2017. That has created a much improved positive backdrop for Asian markets, in both equities and fixed income.’ This has been reflected in faithful investor interest. Inflows have been significant across the region and beyond, with only relatively minor outflows amid the recent periods of market stress. ‘In truth, I don’t think our market saw the kind of outflows that you might have expected in a year like 2018, but interestingly, coming into 2019, we have seen a lot of renewed interest in the asset class, particularly in high yield, but also in products such as fixed maturity funds,’ Ross said. ON THE EDGE As well as the supportive fundamental backdrop, low expected default rates and attractive valuations give Asia an extra edge, according to Neeraj Seth, head of Asian credit at BlackRock. However, the risks to this positive short-term picture are clear and present. ‘From the technical and geopolitical perspective, supply risks and US/China tariffs are a threat in the near term,’ Neth said. ‘Given the adjustment of risk premiums and the positioning and performance of the markets year-to-date – with overall Asian credit markets returning more than 5% and high yield adding more than 8% – investors should be cautious in terms of positioning in the near term.’ As a testament to the fundamental strength of Asian markets, the US/China trade tension has put the region’s credit market through another resilience test – one that it has dealt with well. The JPM JACI Global Diversified (JACI Diversified) index gained 5.2% year-to-30 April.
‘I don’t think our market saw the kind of outflows that you might have expected in a year like 2018’
Ross Dilkes UBS Global Asset Management
‘This is still highly positive when compared with other emerging market corporate fixed income,’ said Cary Yeung and Alain Nsiona Defise, co-managers of the Pictet Asian Corporate Bonds strategy at Pictet Asset Management. ‘Even following the re-escalation of the trade war, JACI Diversified generated a positive 0.3%.’ The Pictet duo suggested that this performance was down to strong fundamentals and technicals, especially in Asian corporate bonds. ‘These positive factors should make investment grade Asian corporate bonds more resilient, but not entirely immune, to an increase in the trade tensions, leaving perhaps just high yield more vulnerable due to higher leverage and less robust technical support.’ WAIT AND SEE However, recent renminbi weakness is a mitigating factor, the pair highlighted, as it enhances the attractiveness of US dollar bonds to China onshore investors, who have become big buyers of Asian credit. ‘With the Chinese government likely to continue to be supportive of liquidity in the financial system, we expect this demand to continue, cushioning any emerging bond fund outflows triggered by the trade tension,’ Yeung and Nsiona Defise said. ‘Following the latest rally, we believe investors are now adopting a wait-and-see approach. But money will be put to work again as we approach the second half of 2019, when the market gets more clarity on the US/China trade tension. ‘Overall, we remain constructive on the asset class given the solid macro/credit fundamentals of Asia as a whole and the attractive relative value it provides compared with other asset classes in the current “yield-chasing” environment.’ THE HUNT IS ON It’s a sentiment broadly echoed by the region’s fund managers, including Neth, who also remains constructive on the markets in the medium term and foresees a resolution to the trade tensions in the coming months, as both the US and China have good reason to avoid deepening the divisions. Putting aside the ‘tensions’, one of the fundamentals that underpins the case for Asian fixed income is the overall need for income, which, Neth argued, remains profound given the demographics in the developed markets and the lack of high quality fixed income assets to choose from. ‘There are still high quality carry opportunities in Asia that should fit the portfolio really well, but we have to differentiate between the local markets and the dollar-denominated markets in this part of the world.’
With this in mind, Neth said that markets such as Indonesia, India and to a lesser degree Malaysia and the Philippines remain attractive, as these countries may still have interest rate cuts ahead, he suggested. Meanwhile, in hard currency credit, he maintains a positive stance on Asian investment grade credit generally, getting more selectively on Asian high yield, especially in China and Indonesia. Focusing on India, one of Neth’s local market stars, he posited a near-term caveat. ‘Given the risks around slowing growth and tightening financial conditions in the onshore market, we are cautious.’ Caution is also nudging Jamie Grant, First State Investments’ head of Asian fixed income, into certain countries in search of lower beta. Singapore and Hong Kong are his natural favourites, but he is also backing China, which you cannot avoid being invested in, he said. ‘It is the most significant part of the market. What we’ve done is really reduce the beta out of our portfolios, so we have the highest quality Chinese risk.’ Areas of concern for Grant are also India, as well as Indonesia, which he said is an interesting one due to its poor data. ‘It’s one of the most volatile names in our index, so it’s always something to be very cautious on.’ OPENING UP CHINA As Neth mentioned, you need to differentiate between local and dollar-denominated markets in Asia, which in most cases means lower flows and client demand for local markets and currencies. But it’s getting harder to consider China part of this regional basket, said UBS’ Dilkes. ‘You do see interest in certain local markets, but again it’s very selective, it’s not a broad investor view. The one outlier to this is China. It has essentially been impossible to allocate to the renminbi market up until the last few years. But a lot has been done in terms of regulatory change and opening up financial markets to allow investors to invest in onshore fixed income, changes including index inclusions has started to generate a huge amount of interest in that space. ‘As one of the largest bond markets globally, if you consider the current allocations to this space, there’s a very big mismatch, and this is not just in terms of retail investors, but more importantly across the institutional landscape as well.’ RMB offerings are typically high quality government bonds, policy bank bonds etc. in terms of the underlying market characteristics. ‘So it’s a safe interest rate sensitive product in the same way you’d look at US Treasury markets and bund markets etc. It’s not an alternative to an Asian credit portfolio in terms of opportunity set, but it is a different type of opportunity,’ Dilkes said. ♦
the jpm jaci global diversified index gained 5.2% year-to-30 april
asian credit markets returned more than 5% to 30 april
asian high yield returned more than 8% to 30 april
the average net debt-to-ebitda ratio of asian corporations is 1.7
foreign investors represent just 2% of china’s rmb-denominated bond market
Strive for consistent income in an uncertain market
As global growth slows and market uncertainties persist over escalating trade tensions, J.P. Morgan Asset Management shares insights on potential opportunities in the fixed income universe. The JPMorgan Income Strategy aims to deliver attractive levels of income by flexibly allocating across sectors.
Q. HOW DO YOU SEEK INCOME TODAY? A. The size of the global bond market is about US$110 trillion¹ and income opportunities exist across a wide range of fixed income sectors from government bonds and investment-grade corporate bonds to non-traditional ones such as high-yield corporate bonds and securitised debt. An unconstrained fixed income strategy, which seeks and achieves risk reduction through diversification², harvests uncorrelated risk premiums from the global fixed income landscape. We believe this is key to income generation. We strive to achieve risk reduction through diversification² in a fixed income portfolio, while aiming to preserve almost all of the expected return even in some of the highest-yielding segments of the market. One of the approaches we take to achieve this is by harvesting uncorrelated, or at times negatively-correlated risk premiums from throughout the global fixed income landscape. Corporate credit risk is a familiar one. We also manage duration risk, sovereign risk, liquidity risk, consumer credit risk, commercial real estate risk, and mortgage prepayment risk among others. Individual sectors tend to have relatively concentrated risk premiums. We aim to take advantage of this, because the individual sectors or subsectors represent a menu of risk premiums which can then be combined in a customised way. Our aim is to harvest them all, and incorporate them together in a balanced way which could rigorously reduce risk while preserving much of the expected return. This is a critical outcome of our portfolio construction process, and the results bear out real risk reduction through this diversification². Q. WHAT ARE YOUR HIGH-CONVICTION SECTORS? A. With major central banks signaling a more accommodative stance, the odds of a soft landing for the global economy have increased. In our opinion, a recession happening in 2019 or early 2020 is unlikely. This late cycle environment favours the securitised market given the enhanced yield pick-up, short duration, and faster amortising nature of the securities we are able to purchase. We continue to favour asset-backed securities (ABS), which are likely to benefit from continuing strong US consumption. In our opinion the US consumer (the ultimate borrower of the majority of our securitised holdings) continues to look very healthy from a fundamental perspective: household debt service and unemployment rate are at historically low levels, and wage growth is rising. These solid fundamentals are largely isolated from the growing trade tensions between the US and China. This could benefit ABS as these are debt securities created from the pooling of loans and receivables such as auto loans, consumer loans, student loans and credit card receivables. And depending on the outcome of trade negotiations between the US and China, we are also flexible to allocate to other fixed income sectors, such as credit.
For Professional Investors and Financial Intermediaries only. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore and the Securities and Futures Commission in Hong Kong. Investments in funds are not comparable to deposits. Investment involves risk, value of units may rise or fall including loss of any or all of the amount invested. Past performance is not indicative of future performance. Investors should make their own evaluation or seek independent advice before investing. The opinions and views expressed here are as of the date of this publication, which are subject to change and are not be taken as or constructed as investment advice. Issued in Singapore by JPMorgan Asset Management (Singapore) Limited (Co. Reg. No. 197601586K) and in Hong Kong by JPMorgan Funds (Asia) Limited. All rights reserved.
Q. HOW ARE YOU NAVIGATING THE ESCALATING TRADE TENSIONS? A. We have actively managed portfolio duration across fixed income sectors. To navigate the risk of escalating trade tensions, we have slightly increased our duration via US Treasuries, and this has added to performance as rates rallied sharply in May. Meanwhile, we were quick to hedge our high-yield (HY) bond exposure. Nevertheless, fundamentals of HY bonds remain robust as we continue to see support for credit in healthy corporate balance sheets, earnings improvement, and stable leverage ratios. Technicals within HY also look supportive as HY bonds experienced positive inflows year-to-date and demand outweighed supply. We believe there are still selective opportunities in emerging markets. We are monitoring the situation in real-time and looking for the next move. We will also be closely monitoring the evolving commentary from global central banks, growth and inflation data, and cross asset class correlations.
Q. HOW CAN YOU CONTINUE TO FIND INCOME STREAM IN A VOLATILE MARKET? A. Having a high yield-like income stream with much less volatility would be relatively appealing in the current market environment. Our Income Strategy is diversified across risk premiums in order to navigate the volatile market and achieve high risk-adjusted yield. This requires active duration management and flexible asset allocation across all fixed income sectors. We are dynamic in shifting our allocations for different market environments. We strive to have more flexibility to pay consistent income in a sustainable way, via an income bank mechanism. This mechanism could protect against changes in interest rates, smooth lumpy cash flow distributions and facilitate sector rotation in order to manage risk, take profits or capture market opportunity. Market volatility can be unsettling. Our 280+ investment professionals from our global fixed income platform, alongside a robust investment process, aim to provide flexibility while dynamically managing the portfolio during volatile market conditions.
¹Source: Bank for International Settlement, as of 31.03.2019. Refers to the outstanding amount of global debt securities which include domestic debt securities and international debt securities issued by general governments, financial corporations, non-financial corporations and international organisations. ²Diversification does not guarantee positive returns or eliminate risk. Provided for information only based on current market conditions subject to change from time to time, not to be construed as investment recommendation. Forecast/Estimates may or may not come to pass. ³Source: FactSet, FRB, J.P. Morgan Asset Management, Bureau of Economic Analysis. **1Q19 figures for household net worth are J.P. Morgan Asset Management estimates. Past performance is not a reliable indicator of current and future results. Data reflect most recently available as of 31.03.2019.
Neil Johnson discovers how the burgeoning market for Asia’s green bonds is helping to strike a blow for sustainable investments
© Photo from Getty Images
IN HIS MEMOIR What I talk about when I talk about running, Japanese author Haruki Murakami examines something that might seem a little surprising to the outsider: the symbiotic relationship between his writing and the meditative experience of long-distance running. It may be unexpected, but to him, it’s completely natural. For Paul Griffiths, global chief investment officer, fixed income and multi-asset solutions at First State Investments, there’s a similarly natural relationship between ESG investing (environmental, social and governance) and fixed income – even if most of the talk around ESG has traditionally centred around equities. First State’s approach to ESG has been years in the making – the firm published its 11th annual responsible investing report in 2018 – and is embedded in every aspect of the investment process. ‘It’s not a bolt-on at the end, and it’s not a recent addition,’ Grant explained. ‘We see ESG as a series of risks that have been applied to equity markets for years. But given the structure of the bond markets – that is, a massive asymmetric risk in terms of capital loss on the downside and yield on the upside – having a good and systematic understanding of what your risks are seems self-evident. ‘Quantifying and assessing those risks through ESG, effectively trying to find value and make a judgment call about them, seems to us to be a no-brainer in terms of how you look at fixed income investing.’ For example, in 2015 and 2016, Chinese property companies were being pulled up for poor practices. The Chinese Communist Party then decided to make it a key focus. ‘The G part of our ESG had been flagging poor governance well in advance, and when the market woke up to what the Party was going to do, resulting in several chairmen being arrested, unsurprisingly it reacted very negatively. But if we had not done an ESG assessment and it hadn’t been flagged, we may have been holding those securities,’ said Jamie Grant, head of emerging markets and Asia Fixed Income at First State Investments.
‘We have moved from a “why?” to a “why not?” moment in sustainable investing’
Venn Saltirov BlackRock
To this end, one of Spence’s key development themes in ESG fixed income is measurement and reporting, as he still sees significant gaps in third-party ESG coverage of the fixed income markets. ‘For example, about 20% to 40% of high yield and emerging market corporate issuers are not fully covered, and there is little to no coverage of the securitisation market. ‘In addition, investors may need to view fixed income ESG scores through a different lens. Most ESG scores originated in the equity market at the parent level, whereas debt issued at a subsidiary level may correspond to an entirely different industry classification, or the issuing entity may be completely removed from specific ESG concerns at the parent level.’ Such a lag is clear in Asia in particular, said Venn Saltirov, vice president and a credit analyst in BlackRock’s Asian credit team. ‘We are in the early stages of commercialising the sustainable investment opportunity in Asian credit. There is an increasing demand from investors for greater transparency, reporting and the standardisation of sustainability-related products. ‘Increasing transparency and reporting have been a focus of our sustainable investment strategy. These are critical in supporting market growth. We have the capability to standardise ESG and carbon reporting using our portfolio management system.’ GREEN SURGE Such teething issues – concentration, standardisation, transparency and impact reporting requirements – are present in the nascent green bond market too. Nevertheless, from a low base, the green bond market has experienced significant growth. ‘Investors are now paying more attention to how the proceeds of a bond are being used and what their impact is on environmental and social aspects. This is where green, social and sustainability bonds come in,’ said Joep Huntjens, head of Asian fixed income at NN Investment Partners. And the trend for green bonds is set to continue given a supportive market backdrop, including heightened governmental commitment to addressing climate change in the wake of the Paris climate agreement and growing numbers of repeat green bond issuers. Green bonds specifically target positive, measurable environmental impact. According to Bloomberg, the market for green bonds has grown considerably over the past 10 years, reaching about $334 billion as of 2018, with China being the largest issuer globally. ‘The size of the market means that green bonds have enough liquidity and diversity for investors,’ Huntjens said. ‘Currently, there is strong demand from European investors for Asian green bonds. ‘Over time, we expect Asian investors to put more emphasis on the impact of their investments. This expected increase in local demand combined with some substantial infrastructure needs in the regions and the government pressure to reduce negative environmental impact are the main drivers for our growth expectation for the Asian green bond market in the coming years.’ BlackRock’s Saltirov is also on board with green bonds. ‘We have moved from a “why?” to a “why not?” moment in sustainable investing,’ he said. ‘In Asia, India, China and Japan are among the countries working to foster local issuance. The private sector – companies and investors – are increasingly recognising the climate risks and the need to transition to a low carbon economy. As such, we see growth potential substantiated by the challenges facing existing businesses and the profit motive.’ ♦
in 2018, the green bond market was worth $334 billion
there was $47.9 billion of green bonds issued in the first quarter of 2019
green bond issuance grew by 42% in the first quarter of 2019
the largest green bond issued in the first quarter of 2019 was worth $2.3 billion
up to $5 trillion is needed annually to achieve the un sdgs by 2030
Grant wasn’t able to pinpoint when ESG will become a really significant factor in Asia, but he was confident that it will happen. ‘We continue to engage with clients who want to engage. Countries such as Singapore and Hong Kong are always naturally at the forefront of this way of thinking. Regulators are starting to think, but they’re still some way behind, and because we’re so passionate about this, we’re ready and willing to help whoever needs help and our experience.’ BOOSTING PERFORMANCE From the perspective of the issuer, Travis Spence, head of EMEA investment specialists for fixed income at JP Morgan Asset Management, said that he expects issuers that conduct business in a sustainable manner and demonstrate high standards to perform better over the long term. ‘Our own proprietary analysis in both the investment grade and high yield markets has supported the idea that higher quality ESG issuers have not only produced higher returns, but also higher Sharpe ratios based on lower drawdown and annualised risk.’
In 2019 so far, Asian credit has recovered much of the lost ground from 2018. However, given the extent of the spread widening in 2018, we still find the valuation at this point relatively more attractive than US and Emerging Market equivalents. On fundamental grounds, the trend for deleveraging continues while the pause in US Fed rate hikes provides a more constructive backdrop for fixed
Asian Credit: Top two Areas of Opportunity
Asia High Yield anticipated to offer attractive opportunities
income. The stimulus from China has resulted in encouraging data releases so far for an economic recovery even though escalating trade tensions may create bouts of risk-off price action. On technicals, we have seen significant primary issuance so far this year, but with fund flows waiting to be deployed, the market has a strong capability to digest the upcoming supply. Despite historical higher volatility, we favour Asian high yield over investment grade since we view valuations as more attractive. However, it is important to note that careful credit selection and active portfolio management are crucial to manage the myriad risks and seek returns in this sector. Two key sectors where we are currently identifying potential opportunities: • Leading Chinese property developers: We favour the consolidators as they continue to gain market share and economies of scale. Flexibility in their debt profile has also improved with a more active onshore funding market. Recent recovery of the physical market came earlier than expected particularly for cities that have seen selective easing. • Asia transportation infrastructure companies: In addition to potentially benefiting from government stimulus policies, we also see increasing passenger traffic as likely to further bolster their project development. Two areas where we are exercising particular caution: • Metals and mining companies across the region: There has been volatility in commodity prices with coal prices being a notable example. We see less room for credit rating upgrades in 2019 and the risk/reward is skewed to the downside given the economic backdrop. • China local government financing vehicles: 2019 may be a year where LGFVs may struggle with re-financing while the implicit support that was long assumed by the market may see changes in terms of policy direction or stress test by authorities.
STEPHEN CHANG Portfolio Manager, Asia
All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. PIMCO Asia Pte Ltd is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. PIMCO Asia Limited is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. This material has not been reviewed by the Securities and Futures Commission. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2019, PIMCO.
By Ishika Mookerjee
After losing his rating six months ago, Arthur Lau from PineBridge Investments is back in the charts with a Citywire + rating. Hong Kong-based Lau is currently PineBridge’s co-head of emerging markets fixed income and head of Asia ex-Japan fixed income. Together with + rated Omar Slim, he also manages the PineBridge Asia Pacific Investment Grade Bond fund. Over the past three years ending 30 April, this fund notched up returns of 8.4%, contributing to Lau’s total returns of 10.7%. The fund invests in short-, medium- and long-term debt, with at least 70% of the net asset value in securities predominantly denominated in US dollars.
Arthur Lau PineBridge Investments
HIGH-FLYER
manager ratio:
manager TR:
three-year ranking:
average manager tr:
0.08
10.7%
30/50
11.5%
sector:
Bonds - Asia Pacific Hard Currency
benchmark:
JP Morgan EMBI+ Asia
benchmark performance:
12.6%
Total returns calculated in USD, gross of tax, ignoring the effect of initial charges and with income reinvested at the ex-dividend date. Source: Citywire Discovery/Lipper / Data over three years to 30 April 2019.
13.0%
0.01
17/50
Neuberger Berman manager Jennifer Gorgoll received her first-ever Citywire rating in April. Having joined the firm in 2013, she is the lead portfolio manager on the emerging markets corporate debt team. Gorgoll manages the Neuberger Berman Asian Debt Hard Currency fund alongside Nish Popat and Prashant Singh. The vehicle invests in debt securities and money market instruments issued by governments, government agencies and corporate issuers in Asian countries. Over the past three years, Gorgoll has returned 13% in US dollar terms versus 11.5% for the average manager in her category, in which she ranks 17th out of 50 managers.
Jennifer Gorgoll Neuberger Berman
+ rated debut
Bonds - Asia Pacific Local Currency
Bloomberg Barclays Asia Local Curr Diversified TR
5.6%
7.4%
0.05
18/30
Vivek Ahuja, portfolio manager and research analyst at Franklin Templeton, fought his way back into our ratings after a three-year hiatus. Ahuja co-manages the Templeton Asian Bond fund with + rated Michael Hasenstab. As of the end of April, more than a quarter of the $464 million strategy was invested in Indonesia, followed by India (25.2%), Thailand (14.9%) and South Korea (10.4%). Nearly a third of the fund’s holdings are BBB credit, with about 25% allocated to BBB-. Ahuja has gained 7.4% in US dollar terms over the past three years, outperforming his benchmark, which delivered 5.6%. He ranked 18th out of the 30 managers tracked by Citywire in his category.
Vivek Ahuja Franklin Templeton Investments
comeback star
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