Asia fixed income offers investors attractive total return potential and distinct investment characteristics that can help improve the overall risk/return profiles of their fixed income holdings. For U.S. investors whose fixed income portfolios are predominantly exposed to the U.S. fixed income markets, Asia fixed income provides currency diversification, the potential for yield enhancement and exposure to markets that follow different economic and credit cycles.
Challenges for Fixed Income Investors
In a low-yield environment, many investors may already be looking outside traditional fixed income benchmarks for yields. For example, some investors may be adding high yield, global or emerging market bonds to their portfolios, rather than relying exclusively on traditional exposures such as the Barclays Global Aggregate Index (Global Aggregate) or the Barclays U.S. Aggregate Bond Index (U.S. Aggregate). The result is a global search for yield. However, in a difficult environment for fixed income investing, some investors may be tempted to reach for yield without thoroughly considering how much risk is being added in exchange for the incremental yield gained.
Investors also recognize the need to include a more diverse range of bonds in client portfolios in order to create ‘all-weather’ investment strategies. Recent increases in duration and in the correlations among common fixed income investments lurk in the background. The U.S. Aggregate, which contains a mix of bond sectors, can provide a starting point for viewing some of the trends taking place in the broader fixed income marketplace. Consider changes in the index over the past decade. Duration in the index has increased by 1.3 years, while the proportion of Treasuries in the index grew by 11.1 percentage points.
As duration in the U.S. Aggregate has increased, investors using the index as a core bond holding may be subject to higher levels of interest rate risk than in the past. In addition, diversity of the index has decreased as the proportion of Treasuries has increased.
A More Efficient Fixed Income Portfolio
Asia fixed income has the potential to help investors achieve higher yield and better total return for their fixed income portfolios within a defined risk/return framework. In other words, adding Asia fixed income to an investor’s overall fixed income portfolio may create a more efficient portfolio on a risk-adjusted basis over the long term.
With a long-term perspective in mind, investors may reap the rewards of investing over a full market cycle. If we compare the risk/return characteristics of the local currency denominated Asia Bond (HSBC Asian Local Bond Index) and the U.S. dollar denominated Asia Bond (J.P. Morgan Asia Credit Index) against a range of core developed and emerging market indices we would illustrate where Asia fixed income is positioned along the risk/return continuum, and provide investors with a distinct asset class in either local or U.S. dollar currency and delivering an attractive return per unit of risk.
Asian fixed income historically has also exhibited relatively low sensitivity to U.S. interest rates compared to other mainstream fixed income segments.
We note that, over the short term, Asia fixed income has the potential to be more volatile than U.S. bonds or Global bonds and therefore investors to have a time horizon of at least three to five years in mind when considering Asia fixed income.
Multi-Currency Bond Portfolios Offer Fixed Income Diversification Benefits
Asia fixed income represents two distinct bond markets—local currency and U.S. dollar bonds. The local currency bond market, represented by the HSBC Asian Local Bond Index, is about $1.73 trillion (larger than the U.S. high yield bond market) and offers currency diversification. The U.S. dollar bond market in Asia, represented by the J.P. Morgan Asia Credit Index, is about $570.5 billion. These two markets together provide compelling investment opportunities across the three return drivers of credit, currencies and interest rates.
Although predictions regarding currencies can be difficult over a short-term horizon, we believe that over the long run there is a strong structural argument for the appreciation of many Asian currencies relative to major global currencies. In many Asian countries today, we see healthy government and corporate balance sheets, falling inflation, higher foreign exchange reserves and lower external debt. We believe that strong regional fundamentals—absolute and relative—combined with deepening capital markets and different interest rate cycles make a compelling case for including local Asia currency exposure in investors’ portfolios.