“Even global bond indices, such as the Lehman Aggregate Bond, only have a mere 2% allocated to the region, with ironically the largest weightings given to those countries most indebted.”
Andy Howse, fixed income product director at Fidelity International, believes Far East bonds offer UK investors a number advantages over UK bonds, in particular the potential for higher yields and capital appreciation by accessing one of the strongest growing regions in the world, diversification from other global bond markets due to different economic fundamentals, and the potential for currency appreciation in domestic Asian bond issues over the medium to longer term. Michael points out that there are some quite large bond markets in Asia, which are by no means fully developed but which continue to mature.
"Returns have been attractive, volatilities low and diversification benefits substantial. Both dollar bond and local currency issuance has picked up, and this of course reflects the improving credit worthiness of sovereigns and corporates as well as relatively low global interest rates. That, and the global search for yield, has ensured that returns have been very strong."
Issuance is likely to increase to service the region’s extensive growth needs, says Howse. "Domestic bond issuance is also likely to expand as governments and companies look to fund in their domestic currencies. The ability to access these markets as they mature will definitely provide investors with a much increased opportunity set in a region where fundamentals remain very attractive."
Howse also points out that since most external debt issued by Asian countries is denominated in US dollars, there is not necessarily a need to take on currency risk. Alternatively, the investor can choose to invest against a local Asian currency benchmark such as the HSBC Asian Local Bond index.
For Colin Harte, director of fixed income and currency at Baring Asset Management., currency exposure offers a positive potential source of returns.
"You really approach some of the Asian markets with currency opportunities. We have used Asian currencies such as the Singapore dollar aggressively to get returns." He says that markets such as Malaysia, Singapore, China and Korea have certain capital controls which mean one has to buy the underlying instruments; therefore a fund is a better way to access them.
There are some risks attached to investing in this area; one of these, and which is sometimes played down by proponents is political risk, Harte says.
"We had issues in Thailand after the coup, for example. But with a bias towards Asian markets in particular you should be okay. What’s important in choosing these funds is what you want to achieve. I think the potential biggest danger is that themes become very fashionable; people jump on the bandwagon. You need to look for people that have expertise in these markets."
There are many diversification benefits. These include exposure to rapid GDP growth; exposure to Asian corporate fundamentals and Asia specific themes such as the emergence of China and India’s middle class and commodity plays; higher yielding bonds that are attractive on a risk-adjusted basis relative to other global bonds and the potential for currency appreciation for domestic Asian issues.