Published August 27, 2014
Upside in Asian bonds if US lifts rates
By
genevieve cua
INVESTORS in fixed income assets see potential rate hikes in the United States as a big bugbear. But Rajeev De Mello, Schroders head of Asian fixed income, see pockets of opportunity, particularly in the rate differentials that local currency Asian bonds offer over US Treasuries.
This reflects the fact that Asian economies are at differing points in their monetary policy cycle, relative to the US. When rate cuts were widespread in Western economies following the 2008 crisis, many in Asia actually raised rates.
My comments: Asia and Emerging Countries are actually experiencing yield curve inversions. In such cases it means they are likely to enter a monetary loosening cycle. This is very beneficial for bond prices, especially for local currencies.
"Now we are at a point where rate cuts are being instigated in parts of Asia, and this is where we believe value can be found. China was tightening until February this year, but the government has now started cutting rates. This loosening is positive for bonds, and we see similar opportunities in India and Indonesia."
Mr De Mello, whose unit manages US$8.5 billion in Asian fixed income, said that Asian yields are at an "interesting" level compared to the US.
"While US's 10-year (Treasuries) is at 2.4 per cent, India's 10-year bond is at 8.5 per cent, and Indonesia's at 8.3 per cent. That's a nice cushion even though investors have currency risks. In those countries that have hiked rates, bond yields are substantially higher than the US and that's a huge opportunity."
In the corporate bond space, there are also opportunities in the spread differential between Asian and US investment grade and high yield bonds. Investors have to weigh their investment horizon against the probability and expectation of a rate hike in the US. The widespread expectation is a rate hike in mid-2015, he added.
"We have to be realistic. The Fed will probably start hiking rates in a gradual fashion from the middle of next year. If the increase is in June or the third quarter, and investors are short term, they will have to be cautious about any bond linked to the US."
He said that markets appear to have priced in hikes of about 100 basis points, starting perhaps in June 2015, and another 100 basis points 12 months after that. To date, demand for income has remained strong, and corporate issues particularly in Asia have been snapped up. This has led, however, to a deterioration in quality.
"Issuers have become more fussy on the conditions and guarantees they are willing to give to buyers. Covenants have been loosened in high yield, and companies of lower rating have been able to come to market . . . Those themes accompany the advanced part of the cycle, although I wouldn't say it signals an end."
In screening for corporate issues, the firm scrutinises financial metrics, particularly cash flow and leverage. It seeks out companies where leverage ratios are healthy and expected to improve, and where management is focused on cash flow rather than just on earnings and earnings growth. It also monitors the impact of currency movements on a company's liabilities and ability to service debt.
One positive underpinning is that default rates in Asia are expected to remain low. "Default rates rise when growth slows and when central banks start to hike rates which causes slower growth or big currency movements. None of those are obvious now. So we're comfortable about default rates."
This reflects the fact that Asian economies are at differing points in their monetary policy cycle, relative to the US. When rate cuts were widespread in Western economies following the 2008 crisis, many in Asia actually raised rates.
My comments: Asia and Emerging Countries are actually experiencing yield curve inversions. In such cases it means they are likely to enter a monetary loosening cycle. This is very beneficial for bond prices, especially for local currencies.
"Now we are at a point where rate cuts are being instigated in parts of Asia, and this is where we believe value can be found. China was tightening until February this year, but the government has now started cutting rates. This loosening is positive for bonds, and we see similar opportunities in India and Indonesia."
Mr De Mello, whose unit manages US$8.5 billion in Asian fixed income, said that Asian yields are at an "interesting" level compared to the US.
"While US's 10-year (Treasuries) is at 2.4 per cent, India's 10-year bond is at 8.5 per cent, and Indonesia's at 8.3 per cent. That's a nice cushion even though investors have currency risks. In those countries that have hiked rates, bond yields are substantially higher than the US and that's a huge opportunity."
In the corporate bond space, there are also opportunities in the spread differential between Asian and US investment grade and high yield bonds. Investors have to weigh their investment horizon against the probability and expectation of a rate hike in the US. The widespread expectation is a rate hike in mid-2015, he added.
"We have to be realistic. The Fed will probably start hiking rates in a gradual fashion from the middle of next year. If the increase is in June or the third quarter, and investors are short term, they will have to be cautious about any bond linked to the US."
He said that markets appear to have priced in hikes of about 100 basis points, starting perhaps in June 2015, and another 100 basis points 12 months after that. To date, demand for income has remained strong, and corporate issues particularly in Asia have been snapped up. This has led, however, to a deterioration in quality.
"Issuers have become more fussy on the conditions and guarantees they are willing to give to buyers. Covenants have been loosened in high yield, and companies of lower rating have been able to come to market . . . Those themes accompany the advanced part of the cycle, although I wouldn't say it signals an end."
In screening for corporate issues, the firm scrutinises financial metrics, particularly cash flow and leverage. It seeks out companies where leverage ratios are healthy and expected to improve, and where management is focused on cash flow rather than just on earnings and earnings growth. It also monitors the impact of currency movements on a company's liabilities and ability to service debt.
One positive underpinning is that default rates in Asia are expected to remain low. "Default rates rise when growth slows and when central banks start to hike rates which causes slower growth or big currency movements. None of those are obvious now. So we're comfortable about default rates."
