Risks and Opportunities in Asia Fixed Income

Introduction

With the COVID-19 pandemic at times bringing global economic activity to a virtual standstill in 2020, financial markets across all asset classes exhibited extreme volatility. As the year progressed, monetary and fiscal authorities across the globe strengthened and coordinated their efforts to restore calm. As a result, global risk assets went on to stage something of a recovery.

In Asia, several economies experienced technical recessions, making this recovery uneven and partial. In the fixed income market, Asian local government bonds recorded positive total returns, while the the US Dollar weakened against most regional currencies amid the positive risk tone. During 2021, global growth is anticipated to continue, but the pace of recovery is likely to remain uneven between economies.

In today’s low interest rate environment, generating positive returns in a core fixed income portfolio is more challenging than ever. Traditional government bonds struggle to deliver results of the past, leaving investors to take on more risk to get the returns they need. Investors require a different approach to these challenges.

How can you navigate the current environment to overcome the low interest rates, mitigate risks and find opportunities to get the returns you need? These are issues that we’ll be exploring in this article.

Risk Factors In Asia Fixed Income

Thanks to a persistent low-rate environment and evidence of economic growth worldwide, equities remain the favoured asset class. However, investors should expect volatility to continue. In the fixed income sector, an improving economic environment should reduce default risk, but favour high quality credits.

Within equities, fund managers expect a rotation into sectors that were most adversely affected by COVID-19. Investors must however be prepared to embrace higher risk or equities in order to attain their return targets, due to lower expected returns in bonds in an atmosphere of low interest rates and tight credit spreads.

In government bonds, corporate credit, and emerging market debt, fixed income valuations are likely to remain expensive, suggesting that the key source of return will be the bonds’ interest. This factor will be mitigated to some extent by the fact that improvements in the global economy and more effective monetary policies should foster below average rates of default in corporate HY bonds and EM debt.1

A preference for HY and EM debt however introduces a moderate level of risk for income-generating funds. Global growth in equities will likely coincide with a rotation within markets, rather than a broad rally. In this atmosphere, flexibly managing equity risk using derivatives and investing in Chinese government bonds and the Japanese yen may improve fund resilience.

Drivers Of Growth Opportunity

According to a recent analysis by JP Morgan, the continuing evolution of Asia’s economies could offer opportunities for diversification and structural growth. The rise of the middle class and lifestyle changes could play a significant role, as an increase in income could drive wealthy consumers to pursue higher quality lifestyles, and increase consumption.

Technology adoption and a rising demand for technological products and services are benefiting market leaders in Asia, with the region being home to some of the world’s leading companies in growth sectors such as internet, technology, and consumer goods. With a diverse mix of businesses in ASEAN, the region is well-placed for further supply chain diversification and some long-term structural gains.

Opportunities In Asia Fixed Income

Digital transformation and acceleration during the pandemic have fuelled a significant rise in eCommerce in Asia, and market penetration is likely to continue as the shift towards 5G technologies gathers pace in 2021. Rising prices for memory will likely favour 5G chip-makers, as the continuing digitalisation of many sectors of the economy drives demand for increased processing power, storage capacity, and network bandwidth.

Regulatory support and increased interest among corporate investors for low-carbon initiatives will yield positive results for businesses offering products and services in the energy transition to low carbon and low emissions sectors. Continued development is anticipated in sustainable investment opportunities in Asia, including strong growth in ESG (Environmental, Social and Governance) bond markets.3

With real interest rates remaining low and perhaps moving lower as inflationary pressures build up, gold and gold stocks should return to their medium term upward trends, following some initial consolidation.

Asia fixed income continues to provide high income with stable fundamentals. Relative valuations in Asia are also attractive. As the global economy moves towards a gradual recovery, this recovery may be uneven -- so credit selection will be key in Asia.4

Regional Highlights

China: Chinese bonds may remain weak in the near-term as the Chinese central bank resists the urge to ease monetary policy. However, bond yields are likely to continue rising gradually. The yuan has continued to appreciate against the US Dollar in the wake of the US Presidential election, and the currency will likely continue to outperform against its regional counterparts in the near to medium term.5

India: An recent unanticipated surge in COVID-19 infections may negatively impact the economic recovery. However, the Reserve Bank of India’s unconventional tools and bond-supportive measures have provided strong support for Indian bonds in recent months.6

Indonesia: With domestic COVID-19 infection rates stable but still high, households and corporate investors remain cautious on spending. However, the government may accelerate disbursements of fiscal expenditures, which should continue to be the main driver of growth in the next few months.7

Singapore: With ample domestic liquidity and an attractive currency in the Singapore dollar (SGD), Singaporean bonds are likely to continue their strong performance.8

Thailand: The potential for rate cuts may support bond demand, especially as domestic liquidity is flush. Offshore investors may prefer bonds that provide better risk-reward.9

Taking A Pragmatic Approach To Opportunities

With the ASEAN region looking on track to reopen, the “lower-for-longer” interest-rate environment is pushing investors further out the risk curve in search of income. Some analysts project that the low interest rate environment may be with us for the better part of a decade. So in order to generate the income they require, investors may have to take on more risk and tap higher-yielding instruments such as infrastructure and agriculture, which were previously under utilised.

Sectors like manufacturing and technology that provided essential commodities during the pandemic will continue to grow, while more demand-driven sectors such as services and retail may continue to decline.10

As the roll out of COVID-19 vaccines gathers pace and gives scope for the normalisation of economies and the reopening of borders, keeping assets invested and diversifying will continue to benefit investors in 2021. The anticipated sector rotation in Asian equities will also present opportunities for fixed income investors to capture alpha.

References

1. Themes expected to play out in 2021, businesstimes.com.sg

2. Trends shaping Asia today, am.jpmorgan.com

3. Themes expected to play out in 2021, businesstimes.com.sg

4. Themes expected to play out in 2021, businesstimes.com.sg

5. 2021 Asian Fixed Income and FX Outlook

6. 2021 Asian Fixed Income and FX Outlook

7. 2021 Asian Fixed Income and FX Outlook

8. 2021 Asian Fixed Income and FX Outlook

9. 2021 Asian Fixed Income and FX Outlook

10. 2021 Investment Outlook: Asia and Emerging Markets poised to lead global economic recovery, www.globenewswire.com