Why Asia deserves another look
Senior Fixed Income Strategist
Summary: The capital flight precipitated by the ever-rumbling trade war between the US and China has made many investors wary of Asian bonds. But despite the many political and economic threats, there are still niche opportunities that are worthy of investigation.
However, the resultant capital flight from the region means that domestic and international investors can now take their pick from attractive investment opportunities among a range of well-regarded companies that carry good ratings. Indeed, many people who understood this fact bought up plenty of these assets at the beginning of the year, just before the market rallied.
Now that prices are higher than they were a couple of months ago, some wonder whether it makes sense to take on risk in Asian names while the details of the ongoing trade talks between the US and China remain obscure. But the real risk here is that the forthcoming trade deal will not be good for China. We might even see another wave of Asian sell-offs in as yet unknown sectors and companies.
The reality is that every day an investor waits to put his or her money to work the interest it might have earned is lost. For this reason, it is important to investigate opportunities that might lie ahead, but it is even more important to understand how one can take advantage of opportunities that exist at the present moment in time.
We believe that the Asian investment grade corporate bond space is a good place from which to start, compared to sovereign and to the high yield corporate vehicles. There are several reasons for this.
First, investment grade companies have more solid balance sheets that enable them to sustain headwinds deriving from the economy or political upsets. In general, it is very unusual to find an IG company going straight from IG to default. Therefore, as long as an investor buys a bond whose maturity matches his or her investment horizon, even if the mark to market value of the bond falls, it will continue to pay interest and repay the notional value at maturity.
Of course, there’s always the possibility of being caught out in some random fall from grace, but such occurrences are very infrequent, and certainly much less common that defaults in the junk space.
Asian investment grade corporate bonds in US dollars offer good pick up on average of 130 basis points over Treasuries. Furthermore, many of these companies have activities all around the globe, meaning that although a great part of their profits can be linked back to Asia, their business model is well diversified, and they are more resilient to a possible Asian slowdown.
Advantages over Treasuries
Companies occupying this niche include highly-rated ones such as Baidu (US056752AM06) with a coupon of 4.375% and expiry 2024 offering a yield of 3.7%. This bond offers 120bps over Treasuries for a rating of A from Fitch and A3 from Moody’s. We can also find an international financial conglomerate such as Mitsubishi UFJ Financial Group with senior unsecured bonds with a coupon of 4.05% and maturity September 2028 (US606822BC70), offering a yield of 3.4% which is 80 bps over Treasuries.
Remaining in the investment grade space, but going lower in rating, we can find the Indonesian state-owned oil and natural gas corporation Pertamina Persero, which is rated Baa2 from Moody’s and BBB- by Fitch. It offers 30-year bonds with a coupon of 6.5% and maturity in November 2048 (US69370RAC16) bearing a yield of 5.7%.
It should be noted that although these long-term maturities bonds are more sensitive to volatility arising from trade wars, economic slowdowns and shifts in oil prices, a yield of nearly 6% for a state owned company might be a good compromise, especially for institutional clients who can take duration risk as part of a well-diversified portfolio.
At this point of time investment grade corporates look to have more value compared to emerging market sovereigns, especially Asian sovereigns. As a matter of fact, Asian sovereigns have rallied excessively since the beginning of the year and remain more vulnerable to trade war risk than do investment grade corporate bonds.
By way of illustration, the yield on 10-year Chinese government bonds has decreased from nearly 4% in January 2018 to a low of 3% at the beginning of this month. Similarly, we have seen a lot of other countries in this area take advantage of risk-on sentiment to issue new bonds. For example, the Philippines has issued 10-year notes offering a yield of 3.782% which corresponds to 110bps over US Treasuries. Saudi Arabia too was able to place 10-year and 31-year notes even though the tension and apprehension caused by the killing of the dissident journalist Jamal Khassoggi have not yet faded.
Latest Market Insights
Outrageous Predictions 2023: The War Economy
- The constantly growing global need for energy drives the world's richest to huddle up and launch a R&D project in a size the world hasn't seen since the Manhattan Project gave the US the first atomic bomb.
French President Macron resignsThe political stalemate in France and the rise of Marie Le Pen following the 2022 elections corners President Macron, forcing him to give up on politics and resign from his position. At least for now.
Gold rockets to USD 3,000 as central banks fail on inflation mandateAs markets and central banks realise that the idea that inflation is transitory is wrong, and that prices will remain higher for longer, gold is sent through the roof, hitting a price tag of USD 3,000
EU Army forces EU down path to full unionWith continued challenges in the region and a US military that isn't aggressively enacting its former role as global policeman, the European Union agrees to create its own armed forces, bringing the whole region closer.
A country agrees to ban all meat production by 2030In an effort to become one of the global leaders on the path to net-zero emissions, one country decides to not only put a heavy tax on meat, but to ban domestic production entirely.
UK holds UnBrexit referendumFollowing a recession and domestic pressure, the United Kingdom is thrown into political turmoil that will end with a vote to wind back Brexit.
Widespread price controls are introduced to cap official inflationHistory tells us that with the war economy comes rationing and price controls. And this time is no different, as policymakers introduce strict price controls that lead to a range of unintended consequences.
OPEC+ & Chindia walk out of the IMF, agree to trade with new reserve assetSanctions against Russia have caused widespread turmoil due to US Dollar moves in countries across the globe that don't consider the US an ally. To relieve themselves from this, they leave the IMF and create a new reserve asset.
USDJPY fixed to the USD at 200 as Japan overhauls financial systemFollowing the challenges that faced the Japanese Yen in 2022, the Bank of Japan attempts to keep the currency from sliding. Unsuccessful on the long-term, Japan will launch a reset of its entire financial system.
Tax haven ban kills private equityWith the war economy comes an increased focus on national interests and sovereign nations' ability to assert themselves. In that regard, the OECD countries turn their attention on tax havens and pull the big guns out, banning them altogether.