Outlook AWS
For professional investors and advisers only
December 2013
Schroders
Outlook 2014: Asian Bonds Rajeev De Mello, Head of Asian Fixed Income Speculation surrounding when the US Federal Reserve (Fed) intends to ‘taper’ its massive quantitative easing (QE) programme have dominated the headlines in 2013, both in bond and equity markets throughout Asia. Despite the flows out of Asian fixed income markets following tapering talk in May, the fundamentals for the region remain solid – strong sovereign balance sheets and high growth prospects along with favourable structural growth trends mean that many Asian markets continue to be attractive. Government debt, on the whole, remains low while many have built up large foreign reserves, ensuring flexibility for currency intervention. Against this backdrop of possible tapering, but strong fundamentals, how will Asian bonds fare in 2014? –– Asia continues to offer investors long-term opportunities as both sovereign and credit fundamentals remain sound –– Asian local currency bonds offer a distinct carry advantage over US Treasuries and historically attractive currency valuations –– Asian credits remain stable, backed by healthy balance sheets and relatively low gearing and leverage. High yield credits and convertibles should continue to generate positive returns into 2014.
Asian local bonds: Yield carry and currency valuations offer better return prospects for 2014 Asian local currency bonds have faced headwinds during 2013 with the HSBC ALBI index in negative territory for the 11 months to November 2013 mainly on the back of weakness in India and Indonesia, the two Asian countries with current account deficits. Asian currencies – with the exceptions of the Chinese renminbi and Korean won – have also weakened against the dollar. Looking ahead, we believe that the investment outlook for global fixed income and Asian local currency bonds will be more positive. Whilst the Fed may start its QE tapering process in the first quarter of 2014, it has indicated that it will keep the Fed Funds rate low for a prolonged period of time, possibly until early 2016, as it seeks to boost US employment conditions. Against this backdrop, upward pressure on global bond yields may be lower during 2014 than what we witnessed between April and August this year. In such an environment, Asian local currency bonds offer a distinct carry advantage with an average yield of 4.25% (as measured by the HSBC ALBI index yield) as of the end of November, or a full 305bp over US Treasuries. We believe that this yield advantage will be an important driver of returns of Asian local currency bonds over the next 12 months, particularly as subdued inflation trends and robust current account surpluses limit prospects for (further) rate hikes by central banks across the region.
Outlook 2014: Asian Bonds
“With global growth expected to pick up during 2014, which has historically boded well for Asian exports, and the Fed remaining on hold, Asian currencies may be better supported.”
Likewise, recent currency weakness has left Asian currencies cheap in comparison to their 1.45% average annual appreciation trend over the past 10 years (see figure 1). With global growth expected to pick up during 2014, which has historically boded well for Asian exports, and the Fed remaining on hold, Asian currencies may be better supported during 2014. Moreover, India, Indonesia and Malaysia have implemented various reforms that will bolster their government finances and current account positions in the medium term. Figure 1: Historical contribution of Asian currencies to HSBC ALBI index returns (End 2000 = 100)* 145 140 135 130 125 120 115 110 105
FX Total Return
FX Carry net of USD funding
Nov – 13
Mar – 13
Jul – 12
Nov – 11
Mar – 11
Jul – 10
Nov – 09
Mar – 09
Jul – 08
Nov – 07
Mar – 07
Jul – 06
Nov – 05
Mar – 05
Jul – 04
Nov – 03
Mar – 03
Jul – 02
Nov – 01
Mar – 01
100
HSBC ALBI FX SPOT Index
Source: HSBC, Schroders, as at 03 December 2013. *Based on HSBC ALBI weights, where available. FX carry returns from February 2001-August 2004 may differ from actual returns by approx. 10-20bp per annum due to a lack of USD-MYR NDF point data.
RMB bonds
“We see positive returns on Asian high yield credits continuing next year as the vast majority of Asian credits remain stable.”
China will also continue to provide support to the region. Our outlook for China sees credit growth continue its gradual slowdown, while inflation will remain manageable. In this environment, RMB appreciation should continue to be very gradual. Offshore RMB bonds have returned 5.9% in dollar terms during the first 11 months of this year and offer attractive yields of between 3.2-5.5% to investors. We foresee the trend of increasing issuer diversity continuing next year, while a relatively short duration profile and solid credit fundamentals on many offshore RMB bonds will also be appealing. Likewise, rising yields, amongst the highest globally in real terms, and a stable currency have enhanced the attractiveness of onshore RMB bonds. This should continue as they benefit from offshore demand as the onshore RMB bond market opens up to investors under the Renminbi Qualified Foreign Institutional Investor regime. Giving credit where it’s due Asian corporate credits trade at a sizable liquidity premium versus US corporate credits with high yield Asian USD credits in particular offering attractive yields, while having also traded in a narrow range during the past year, (see figure 2) and increased yield dispersion among issuers – in turn, offering good portfolio alpha generation opportunities.
Outlook 2014: Asian Bonds
Figure 2: Yield and trading range on indices of Asian local currency bonds, Asian USD credits and US Treasuries during 2013 12 10 8 6 4 2
HY CI JA
CI
IG
s JA
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ne
ia es
ia In d
on
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In d
d an ail Th
an Ta iw
or e ap ng
Si
ala
ys
ia
re a M
Ko
HK
H CN
rie s su
Tr ea US
HS
BC
AL
BI
0
Yield
Source: BBG, as at 03 December 2013
Rajeev De Mello Head of Asian Fixed Income Rajeev De Mello is Head of Asian Fixed Income, based in Singapore. He joined Schroders in July 2011 and previously worked at Western Asset Management as Senior Investment Officer, Country Head of Singapore, and member of the Global Investment Strategy Committee. Prior to that, he was Head of Asian Fixed Income at Pictet Asset Management. He started his investment career in 1987 and has a Bachelor of Science in Economics (Hons) from the London School of Economics and an MBA from Georgetown University.
We see positive returns on Asian high yield credits continuing next year as the vast majority of Asian credits remain stable, backed up by fundamentals such as healthy balance sheets and relatively low gearing and leverage. We also see corporate default rates remaining low as refinancing activities have helped Asian companies strengthen their credit profiles. Likewise, Asian convertibles may continue to see positive returns in 2014. Market technicals – notably subdued supply – provide ample support, while convertibles would also benefit from a pick-up in equity market (volatility) given current low levels of implied volatility and positive equity delta exposure. What could go wrong? Strong bank credit growth over the past few years have left selected Asian countries, and particularly banks, vulnerable to tighter financial conditions. Hence, Asian banking systems could be exposed to a tightening of monetary policies by Asian central banks if they were forced to respond to more aggressive-than-expected policy tightening by the Fed. If policy responses faltered, Fed tightening could leave the currencies of these countries vulnerable to weakness. In this respect, selected banks in India and Indonesia are already suffering from deteriorating loan books and tight liquidity conditions, respectively. However, we believe that the fall-out from the sharp rise in US Treasury yields earlier in 2013 have alerted Asian policymakers to the risks associated with the recent strong growth in bank credit, while encouraging them to implement macro-prudential measures to control them. Moreover, rising current account surpluses will better shield Asian banks and currencies in future against rising US interest rates.
Important information: The views and opinions contained herein are those of Rajeev De Mello, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Issued in December 2013 by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA, which is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored. w44762
December 2013
Schroders
Outlook 2014: Asian Bonds Rajeev De Mello, Head of Asian Fixed Income Speculation surrounding when the US Federal Reserve (Fed) intends to ‘taper’ its massive quantitative easing (QE) programme have dominated the headlines in 2013, both in bond and equity markets throughout Asia. Despite the flows out of Asian fixed income markets following tapering talk in May, the fundamentals for the region remain solid – strong sovereign balance sheets and high growth prospects along with favourable structural growth trends mean that many Asian markets continue to be attractive. Government debt, on the whole, remains low while many have built up large foreign reserves, ensuring flexibility for currency intervention. Against this backdrop of possible tapering, but strong fundamentals, how will Asian bonds fare in 2014? –– Asia continues to offer investors long-term opportunities as both sovereign and credit fundamentals remain sound –– Asian local currency bonds offer a distinct carry advantage over US Treasuries and historically attractive currency valuations –– Asian credits remain stable, backed by healthy balance sheets and relatively low gearing and leverage. High yield credits and convertibles should continue to generate positive returns into 2014.
Asian local bonds: Yield carry and currency valuations offer better return prospects for 2014 Asian local currency bonds have faced headwinds during 2013 with the HSBC ALBI index in negative territory for the 11 months to November 2013 mainly on the back of weakness in India and Indonesia, the two Asian countries with current account deficits. Asian currencies – with the exceptions of the Chinese renminbi and Korean won – have also weakened against the dollar. Looking ahead, we believe that the investment outlook for global fixed income and Asian local currency bonds will be more positive. Whilst the Fed may start its QE tapering process in the first quarter of 2014, it has indicated that it will keep the Fed Funds rate low for a prolonged period of time, possibly until early 2016, as it seeks to boost US employment conditions. Against this backdrop, upward pressure on global bond yields may be lower during 2014 than what we witnessed between April and August this year. In such an environment, Asian local currency bonds offer a distinct carry advantage with an average yield of 4.25% (as measured by the HSBC ALBI index yield) as of the end of November, or a full 305bp over US Treasuries. We believe that this yield advantage will be an important driver of returns of Asian local currency bonds over the next 12 months, particularly as subdued inflation trends and robust current account surpluses limit prospects for (further) rate hikes by central banks across the region.
Outlook 2014: Asian Bonds
“With global growth expected to pick up during 2014, which has historically boded well for Asian exports, and the Fed remaining on hold, Asian currencies may be better supported.”
Likewise, recent currency weakness has left Asian currencies cheap in comparison to their 1.45% average annual appreciation trend over the past 10 years (see figure 1). With global growth expected to pick up during 2014, which has historically boded well for Asian exports, and the Fed remaining on hold, Asian currencies may be better supported during 2014. Moreover, India, Indonesia and Malaysia have implemented various reforms that will bolster their government finances and current account positions in the medium term. Figure 1: Historical contribution of Asian currencies to HSBC ALBI index returns (End 2000 = 100)* 145 140 135 130 125 120 115 110 105
FX Total Return
FX Carry net of USD funding
Nov – 13
Mar – 13
Jul – 12
Nov – 11
Mar – 11
Jul – 10
Nov – 09
Mar – 09
Jul – 08
Nov – 07
Mar – 07
Jul – 06
Nov – 05
Mar – 05
Jul – 04
Nov – 03
Mar – 03
Jul – 02
Nov – 01
Mar – 01
100
HSBC ALBI FX SPOT Index
Source: HSBC, Schroders, as at 03 December 2013. *Based on HSBC ALBI weights, where available. FX carry returns from February 2001-August 2004 may differ from actual returns by approx. 10-20bp per annum due to a lack of USD-MYR NDF point data.
RMB bonds
“We see positive returns on Asian high yield credits continuing next year as the vast majority of Asian credits remain stable.”
China will also continue to provide support to the region. Our outlook for China sees credit growth continue its gradual slowdown, while inflation will remain manageable. In this environment, RMB appreciation should continue to be very gradual. Offshore RMB bonds have returned 5.9% in dollar terms during the first 11 months of this year and offer attractive yields of between 3.2-5.5% to investors. We foresee the trend of increasing issuer diversity continuing next year, while a relatively short duration profile and solid credit fundamentals on many offshore RMB bonds will also be appealing. Likewise, rising yields, amongst the highest globally in real terms, and a stable currency have enhanced the attractiveness of onshore RMB bonds. This should continue as they benefit from offshore demand as the onshore RMB bond market opens up to investors under the Renminbi Qualified Foreign Institutional Investor regime. Giving credit where it’s due Asian corporate credits trade at a sizable liquidity premium versus US corporate credits with high yield Asian USD credits in particular offering attractive yields, while having also traded in a narrow range during the past year, (see figure 2) and increased yield dispersion among issuers – in turn, offering good portfolio alpha generation opportunities.
Outlook 2014: Asian Bonds
Figure 2: Yield and trading range on indices of Asian local currency bonds, Asian USD credits and US Treasuries during 2013 12 10 8 6 4 2
HY CI JA
CI
IG
s JA
pi
ne
ia es
ia In d
on
ilip Ph
In d
d an ail Th
an Ta iw
or e ap ng
Si
ala
ys
ia
re a M
Ko
HK
H CN
rie s su
Tr ea US
HS
BC
AL
BI
0
Yield
Source: BBG, as at 03 December 2013
Rajeev De Mello Head of Asian Fixed Income Rajeev De Mello is Head of Asian Fixed Income, based in Singapore. He joined Schroders in July 2011 and previously worked at Western Asset Management as Senior Investment Officer, Country Head of Singapore, and member of the Global Investment Strategy Committee. Prior to that, he was Head of Asian Fixed Income at Pictet Asset Management. He started his investment career in 1987 and has a Bachelor of Science in Economics (Hons) from the London School of Economics and an MBA from Georgetown University.
We see positive returns on Asian high yield credits continuing next year as the vast majority of Asian credits remain stable, backed up by fundamentals such as healthy balance sheets and relatively low gearing and leverage. We also see corporate default rates remaining low as refinancing activities have helped Asian companies strengthen their credit profiles. Likewise, Asian convertibles may continue to see positive returns in 2014. Market technicals – notably subdued supply – provide ample support, while convertibles would also benefit from a pick-up in equity market (volatility) given current low levels of implied volatility and positive equity delta exposure. What could go wrong? Strong bank credit growth over the past few years have left selected Asian countries, and particularly banks, vulnerable to tighter financial conditions. Hence, Asian banking systems could be exposed to a tightening of monetary policies by Asian central banks if they were forced to respond to more aggressive-than-expected policy tightening by the Fed. If policy responses faltered, Fed tightening could leave the currencies of these countries vulnerable to weakness. In this respect, selected banks in India and Indonesia are already suffering from deteriorating loan books and tight liquidity conditions, respectively. However, we believe that the fall-out from the sharp rise in US Treasury yields earlier in 2013 have alerted Asian policymakers to the risks associated with the recent strong growth in bank credit, while encouraging them to implement macro-prudential measures to control them. Moreover, rising current account surpluses will better shield Asian banks and currencies in future against rising US interest rates.
Important information: The views and opinions contained herein are those of Rajeev De Mello, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Issued in December 2013 by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA, which is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored. w44762
