Ross Dilkes, UBS Asset Management (Singapore) executive director and portfolio manager of the UBS (Lux) BS Asian HY $ Q-acc fund, says the recent tide of dovish monetary policies in the region should bode well for Asian fixed income assets. This comes as the US Federal Reserve’s first rate cut in more than a decade prompted Asian central banks to follow suit.
For instance, the Reserve Bank of India slashed interest rates by 35 basis points to 5.4% and the Bank of Thailand cut its one-day repurchase rate by 25bps to 1.5%. In the Philippines, the Bangko Sentral ng Pilipinas reduced the overnight borrowing rate to 4.25%. Other central banks are expected to follow suit.
Such a dovish monetary policy environment should help stimulate growth, which in turn will support fixed income assets amid concerns of a downturn, explains
Dilkes. “[The Fed rate cut] provides a lot more bandwidth for central banks in Asia to be more dovish to support their own economies without fear of potential currency instability or further weakness in external balance. So, this has obviously helped the region,” he tells The Edge Singapore in a recent interview.
Although a dovish monetary policy should also lift equities, the impact will take longer compared with fixed income. In contrast, the impact on the bond markets is more “immediate”, says Adam McCabe, Aberdeen Standard Investments head of fixed income in Asia and Australia.
McCabe adds that Asian fixed income assets are enjoying improved credit ratings as a result of ongoing structural reform in the region. “With reforms [having] become embedded [and] inflation risk premium falling, there is value that can be unlocked from the bond markets,” he says in an interview.
That is perhaps one reason that valuations of fixed income assets across the region are relatively undemanding. “We repriced a lot in 2018. So, even though we have rallied this year, the valuations are really not demanding. There is still attractive-ness in spread products, particularly in the low-yield world,” Dilkes says.
Indeed, fund managers are already starting to rotate into fixed income assets. According to an August fund manager survey conducted by Bank of America Merrill Lynch, the allocation to bonds has climbed 12 percentage points to 22% — the highest allocation since September 2011. In contrast, the allocation to global equities has retraced almost all of July’s uptick, falling 22 percentage points to 12%.
So, where are fund managers seeing opportunities in Asian fixed income?
Sovereign and corporate bonds
From a sovereign perspective, McCabe says India is the “sweet spot”, as the country, under Prime Minister Narendra Modi’s administration, continues to implement economic reforms, thereby improving domestic productive capacity. “It will ensure that inflation is structurally lower and well anchored, coupled with credible monetary policy. You see great opportunity for unlocking value,” he says.
McCabe favours Thailand too. He points out that the country’s economic fundamentals, particularly its current account surplus and relatively stable domestic demand, continue to be positives for the bond market. “In essence, you see more money entering Thailand. It has low beta and is very defensive,” he says.
In addition, McCabe sees opportunities in the Philippines, following the central bank’s aggressive rate hike last year. “One could criticise the central bank for falling behind the curve [on inflation] — tolerating more than the market wanted. But now it is seen as credible by the market,” he says. “That’s a positive.”
In Malaysia, the country’s high credit rating can provide relatively attractive real yields, according to Endre Pedersen, chief investment officer, fixed income, Asia
ex-Japan of Manulife Asset Management. He notes that Malaysian government bonds with longer maturities currently yield between 3.6% and 3.8%. This is helped by low levels of inflation, the lowest in Asia, he adds.
Pedersen also favours Indonesia’s bond market, which has gradually recovered this year. He says Indonesian government bond yields are currently trending lower and the rupiah is trading in a more stable band. “After President Joko Widodo’s convincing electoral victory in April, coupled with Standard & Poor’s credit-rating upgrade in May, we believe that foreign inflows into the country’s bond market should accelerate,” he writes in a July note. “With more supportive market dynamics, Indonesia bonds are positioned to perform, given the potential for rate cuts in the second half of 2019.”
On the other hand, Dilkes prefers corporate bonds. He says corporate earnings and fundamentals in Asia are still attractive relative to those in non-Asian emerging and developed markets. “Right now, corporate credit — especially high-yield ones — are the best risk-return opportunity within the Asian landscape,” he says. “We see limited amounts of stress. So, there is no concern of default.”
Credit quality risks
Still, there are risks ahead. Many fixed income funds are choosing to overlook credit quality to generate higher-yield income. In particular, there has been more demand for securities rated BBB and BBB-, says McCabe. “One needs to be careful in chasing yield for yield’s sake,” he warns. “That sounds alarm bells for me because there does still need to be some differentiation. There are names in the BBB space that may get downgraded.”
Dilkes agrees. “We can probably do better from largely avoiding some of the risk in that space [and] being disciplined in where we access capital. And we don’t need to target a very aggressive spread-tightening environment to see the types of return expectations that we are looking for,” he says.
He acknowledges, however, that tactical allocations will still be made within the poorer credit quality space. “We are obviously an active manager,” says Dilkes. “If we see valuations adjust, that might give us opportunities to [get in]. We will use [market] fluctuations [to position ourselves] over time.”
As at June 30, the UBS (Lux) BS Asian HY $ Q-acc fund’s largest amount of securities by credit quality were those with a B rating (25.4%). This was followed by “others” (15.1%), BB- (14.3%), AAA (13.5%) and B+ (13.2%). Its top three holdings were US Treasury Note/Bond (12.09%), Sri Lanka Government International Bond (6.6%) and China Evergrande Group (6.02%). The fund returned 12.7% for the year to Aug 5 and has a net expense ratio of 0.86%, according to Morningstar data.
Other risks include slowing growth — despite a looser monetary policy environment — which could lead to a recession. When that happens, leverage concerns will come into focus. “A lot of companies can refinance debt and term out their borrowings currently. But, should the economic cycle move into a recession, it will be challenging,” warns McCabe.
While Dilkes believes a looser monetary policy will support growth, he thinks fiscal help is needed too. He is encouraged to see that arguments for austerity and a strict government balance sheet are starting to ease in favour of more government spending. “I think we are seeing a shift back to fiscal but, obviously, it is still a slow process. I think most central banks would hope for more,” he says.
