Asian fixed income, particularly high yield (HY), investment grade (IG), and local currency bonds, present the best opportunities for investors amidst the global uncertainty and market volatility that is expected following the US elections.

This is the consensus among fixed income managers who also warn that capital flows can be adversely impacted by volatility and uncertainty arising from geopolitical events, hence a cautious approach focusing on credit quality and diversification is recommended for investors.

In any case, Asian fixed income is one asset class that outperformed in the past 12 months with Asian HY bonds up by 20%, and Asian IG as well as local currency bonds up by more than 10%.

“For investors who don’t want to take the currency volatility tied to the US dollar, Asian fixed income provides some pickup, about 1.0% to 1.5% versus equivalent US dollar bonds. We see the Asian IG and high-quality local currency bond markets will provide steady and stable returns in the year to come,” says Lei Zhu, head of Asian fixed income at Fidelity International.

Strong demand for new issuances

Although investor flows into Asian bond funds have been muted in the past three years, the primary market demand for new issuances remain supportive, aided in part by favourable market technicals, says Low Guan Yi, head of Asia fixed income at M&G Investments.

“The benign growth landscape, alongside a more accommodative monetary policy stance, should provide a foundation for Asian fixed income performance in our view. Yields in Asian US dollar and domestic bond markets remain relatively attractive, at around 5% and 4% respectively, within the investment-grade segment, compared to levels seen in the last decade,” Low adds.

In terms of fundamentals, most of the economies in Asia have registered strong growth in the past 12 months, including Southeast Asia and India, as well as the frontier economies of Pakistan and Sri Lanka. Going into next year, these macroeconomic growth trends are expected to continue.

The relatively low level of inflation in most Asian economies is also expected to continue. China and Thailand, for example, have inflation rates below 1.0%. In the case of China (0.4%), it’s because of the economic slowdown, while in the case of Thailand (0.35%) it’s mainly due to lower energy prices and subdued domestic demand. The Philippines and Vietnam have inflation rates of around 3.4% each, and Singapore with 2.2%. India currently has the highest inflation rate at 5.0%.

However, the policy rate (interest rate set by the central bank) of each country is currently higher than their inflation rate. For example, the Philippines’ policy rate is around 6.25%, Thailand’s policy rate is about 2.5%, about 3% for Malaysia, close to 2.5% for China, and around 6.5% for India.

The difference between the inflation rate and the policy rate means the real interest rate in these Asia markets is very attractive for local currency fixed income investors.

Room for further rate cuts

Zhu explains that before the US Federal Reserve’s interest rate cut, Asia’s central banks have been constrained from cutting their own rates as it would have meant widening the gap with the US and risked a sell-off in their respective currencies.  That situation changed on September 18 when the Fed finally delivered a 50-basis-point interest rate cut.

“The natural conclusion is that investors should feel more confident adding duration in high-quality bonds, from sovereigns to investment grade. With the exception of Japan, we believe most Asian central banks will feel comfortable trimming policy rates following the Fed’s cuts, given their positive real rates,” Zhu says.

Low adds: “Real yields in Asian domestic bond are also largely positive as inflation moderates. While not the highest in historical or broader emerging market terms, bonds in the region should still offer an appealing combination of stability and income, and diversification from developed markets.”

This view is echoed by Alexander Mackey, co-chief investment officer of fixed income at MFS, who says many developing countries raised interest rates even before their counterparts in developed countries did so, and are now experiencing broad disinflation, and that despite many countries having already started to cut rates, policy levels remain restrictive, with room for further rate declines.

“We believe that the outlook for fixed income investors is positive when considering prospective returns as well as providing effective diversification to equities within multi-asset investment frameworks. Starting yields are an important determinant of long-term returns for fixed income investors. In the current environment, investors can potentially realize both attractive nominal yields as well as capturing significant real rates of return,” says Mackey.