Local heroes – Asian debt offers a positive vision of 2021

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As we move into the final stages of a challenging year, Asian bonds are giving investors a reason to be optimistic.

With only weeks to go until we enter 2021, investors could be forgiven for eyeing the next 12 months with a degree of cautious optimism. Of course, a simple date change won’t erase the traumas of 2020, but after a year of uncertainties there may be reasons to see a glimmer of light at the end of the tunnel.

The VIX Volatility Index, which hit a high of 82.7 in March, has been trading steadily in the 20s since August, and capital markets have steadied to the point that they’ve even taken the unpredictable US election in their stride. What’s more, there is finally some clarity over the direction of bond markets.

Sovereign issuance remains robust, and investors have been snapping up higher-rated and longer-tenor debt in particular. Sustainable investments and environmental, social and governance (ESG) bonds have been the standout plays of the year, and demand is only likely to grow. Asian emerging-market debt has also been solid.

Against the current backdrop of lingering risk aversion, I want to look at three investment themes that still show balanced returns.

A reliable hedge

Government debt has been the cornerstone of many portfolios for much of the year, and safe-haven bonds are likely to remain a reliable hedge for the rest of 2020 and into the first quarter of 2021 as markets navigate multiple risks.

The scale of demand has been illustrated by recent issues in Asia-Pacific. For example, at the end of September, the Australian Office of Financial Management, which sells debt securities on behalf of the Australian government, received bids two-and-a-half times the A$25 billion (US$17.7 billion) on offer for its new 0.5% 2026 bonds¹.

This dynamic was even more apparent in mid-October, with a blockbuster US$6 billion four-tranche bond deal from China, acting through the Ministry of Finance². Books were four-and-a-half times subscribed for the three, five, 10- and 30-year bonds, and investors flooded in from around the globe to the first China sovereign bond in 16 years to print in a 144a format.

Investors have also been attracted by high ratings (Australia is rated Aaa/AAA/AAA, while China is A1/A+/A+), the ability to hedge against riskier assets, and the attractive liquidity of government paper.

The shift towards ESG

It’s no secret that bond markets are perfectly happy to ignore trends and themes but since March there has undoubtedly been a shift towards ESG-related debt, particularly the investment-grade variety.

It remains structurally the most innovative part of the fixed-income space. Across the region there have been, for example, university bonds that address accessibility issues for students during the coronavirus pandemic, financing for geothermal projects, as well as blue bonds used to fund new and existing marine-related projects.

Alternative investments like this are going to remain popular for the foreseeable future for three reasons. Firstly, they bolster the ESG credentials of investors; secondly, the issuers are often highly rated themselves; and finally, because ESG investments are generally positively regarded or supported by central banks, they are perceived as having an additional layer of safety.

Not only do they generally provide a yield pick-up over government bonds, but ESG investments around the globe have also consistently outperformed traditional investments during Covid-19 by 3 to 4 per cent³.

Emerging-market debt remains attractive

Emerging-market local-currency debt was one of the standout winners earlier this year, returning 7.7% in the second quarter, and it is likely to remain attractive for the foreseeable future⁴. Even though the yield on Asian local-currency bonds has tightened dramatically over the past six months, it still provides a clear pick-up over US Treasuries.

Ten-year paper from Vietnam, Malaysia, and Indonesia for example, might have come in 67.8 basis points (bps), 67.7bps and 110.3bps respectively since April. However, they still offer a healthy return over equivalent US Treasuries⁵.

This is also true in the Asian local-currency corporate-debt domain. The markets have remained open for companies across the ratings spectrum; from the third-quarter onwards, even the unrated have been able to raise capital.

The low interest-rate environment is expected to continue into next year, regardless of who wins the election on 3 November. On top of this, a decline in the US dollar, which is currently overvalued by more than 8% and which some economists believe could plunge as much at 35% next year, is likely to support local-currency bond valuations in Asia even further⁶.

Covid-sensitive

Risks do remain, and the global economy will remain covid-sensitive for some time yet. On balance, though, positives forces are holding their ground. The return to growth in many Asian economies will support the expansion of capital markets, which, in turn, provides a solid foundation for the region’s bond markets.

Written by Kheng Siang Ng
Asia Pacific Head of Fixed Income, State Street Global Advisors

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