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Amid low yields and negative rates in developed markets, investors should increasingly add more portfolio exposure to Asian credit as they adapt fixed income allocations.

Key takeaways

• Asia’s solid fundamentals will see the region benefit from the search for yield and diversification by global fixed income investors
• Specific opportunities in Asian credit include Chinese corporate bonds and high yield Chinese property
• The composition of fixed income within portfolios needs to change in pursuit of higher yields

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Where should investors search for yield beyond developed markets?

Raymond Lee: We believe that Asia as part of emerging markets is going to be a beneficiary of this move. Obviously yields and spreads in this part of the world are much higher and certainly positive and so investors are picking up good return for the level of risk they’re taking. The macro outlook in Asia is also fairly stable. They’ve gone through the financial crisis and the Asian financial crisis in a way where their balance sheets have basically improved, and the fundamentals are good and that’s going to flow into corporate credit.

And valuations are also attractive, particularly when you compare it to Europe or even in the US, it trades at a premium. So there’s a good risk-return profile for Asia credit at the moment.

Where specifically in Asia do you see some of the main opportunities within credit?

Raymond Lee: Well, when we talk about Asia credit we really have to talk about China because that’s basically more than half of the market in terms of issuances and bonds outstanding. And at a macro level, we’re still fairly constructive on China, particularly in the middle to longer-term. Obviously there’s a lot of headline around macro risks and headwinds on trade wars, but we believe that the China government has a lot of tools that the western world doesn’t have to manage this slowdown.

In a way where volatility can be managed well, so that there’s no sharp declines. And because of that we’re still happy buying China corporate credit, we think the fundamentals there will still hold up relatively well. Within the investment sector for the more conservative investors, we still like some of the state-owned enterprises out of China. They’re still very high-quality and give a decent return over the risk-free rate. And then within China high-yield, we still like property, particularly the higher-quality property names in the double-B segment and prefer to stay in three-to-five-year tenure range, and not go too long out in duration, to manage the volatility of those holdings.

How should investors reassess the composition of fixed income instruments in their portfolios?

Raymond Lee: Well, in an environment where we have low or negative yields we have to change the way we think about the composition of the fixed income asset allocation portion of a portfolio. With yield so low, the risk-return profile is not as attractive in sovereign debt as it was in the past. A good example is a ten-year US government bond which is yielding about 1.5 per cent at the moment.

What that means is if yields back up 20 basis points, which it can do in a short space of time, it eats up your yearly coupon income. And so that risk-return is not that attractive in sovereign debt at the moment and so what we recommend is to manage exposures in that segment but also complement that with some exposure to credit. Credit can give you additional spread return over the risk-free rate and if you target credit spread products in the three-to-five-year tenure range, you’re not taking too much duration and you can manage the mark to market if valuations move against you.