CORPORATE bonds in emerging markets, such as those issued by banks and insurance companies, are expected to outperform this year, according to Biswaroop Barua, head of fixed income and credit products (group wealth management) at Standard Chartered Bank in Singapore.

In the past few years, banks have become more globally focused, strengthened their risk management processes and had less sensitivity to interest rate risks, he points out.

“We like bank and other corporate bonds in Asia, including the Middle East. That is because banks in these areas are making great strides in becoming significantly stronger and more sophisticated entities. Their risk management processes have also improved by leaps and bounds. Malaysian banks are a classic example of where they have done a very good job to become real leading players in the region,” says Biswaroop.

“At the same time, corporates [in emerging markets] increasingly have a global focus and profile. This growth story is our interest. Today, you have Asian companies that are not only domestic but regional businesses, and some of them have become international companies. We like to focus on companies that have increasing influence beyond just their domestic market,” he told Personal Wealth last month. Biswaroop has been a fixed income product specialist for the past 17 years.

While many take the view that the upcoming US interest rate rise by the Federal Reserve will have a negative impact on markets and businesses globally, Biswaroop says this is part and parcel of the US economy’s normalisation process. He also points out that in such a global environment, corporate bonds are less sensitive to interest rate risks.

“Theoretically, government bonds take on 100% of the interest rate risks, and there are no credit risks. But we advise our clients to focus on corporate bonds, which provide investors with a credit spread,” he says.

“Credit spreads, generally speaking, will remain flattish because spreads have narrowed quite a bit. We don’t expect them to narrow significantly from where we are. We don’t see any systemic credit issue anywhere on the horizon, unless there is a black swan event.”

According to Danny Chang, head of managed investments and product management at Standard Chartered Bank Malaysia, the rising interest rates around the world are a reflection of the improving global economy. And the spillover effects include corporate profitability and balance sheet strength.

“By buying into corporate bonds, you are in a way buying into this strength. That is why our clients who are holding corporate bonds should not worry much about [rising] interest rates, compared with those who are holding only US treasuries or other sovereign bonds,” he says.

Bonds issued by insurance companies are also favoured because the industry is well regulated. In general, we like the insurance sector because it plays a very important role in society, just like banks, says Chang.

“As a result, in most jurisdictions in developed markets, these companies are well regulated. This gives us an extra set of eyes and ears.”

The new normal environment

In a global environment where quantitative easing (QE) is the new normal, a certain level of volatility is unavoidable, says Biswaroop. However, he adds, the policymakers at central banks in key economies such as Europe and Japan, are dealing with the QE well, thus any rise in US interest rates will not have a severe impact on the bond market.

The current situation is different from that of two years ago, when policymakers made unexpected comments that caused even more uncertainty and volatility in the market.

“Whenever there is QE put in place, the market is always concerned about two things ó the timing and how much interest rates will rise. The last time the market focused on rising interest rates was in May 2013, which led to a taper tantrum. These two key questions remain somewhat unanswered today,” says Biswaroop.

This time around, the views of the policymakers are communicated on a regular basis. “The yield curve is likely to flatten. And it will be flat because much of what the policymakers intend to do is well telegraphed. They have been explaining their stance and communicating with the market [regularly],” he says.

“As long as the market is given enough time to digest the information, it is generally quite sanguine. It is able to digest even bad news,” he adds.

“As the [policymakers] get more transparent, the impact of rising rates on the bond market may be more muted. Ultimately, [the interest rate rise] should not have material and lasting adverse impact on the bond market.”

While the broad consensus on the home front is that Bank Negara Malaysia will raise its interest rates when the Fed does, Chang says this is unlikely to happen. He points out that Bank Negara had raised its interest rate by 25 basis points last year while other factors such as the effects of a weaker ringgit and the implementation of the Goods and Services Tax (GST) have yet to be seen.

“I don’t think there is going to be any change to our rate policy. We were [already] slightly ahead in raising interest rates last year. The second thing is from the currency perspective, the ringgit has seen some weakness in the last two months,” he says.

“While our economy is growing about 5%, the [effect of] GST is coming through. I think Bank Negara would like to see how this plays out before making any big moves.”

On bond yields in the near future, Biswaroop expects the focus to be on the 10-year US Treasury note, which has the largest impact on the global market. However, he does not see a spike in interest rates severely impacting the yields of the 5- and 10-year notes.

“The impact on the 10-year Treasury note can be seen in the next six months. I don’t think it takes that much time to play out. During the Federal Open Market Committee (FOMC) meetings, every time there is a sound bite, [the news] gets priced into the 10-year [Treasury] yields,” he says.

“The FOMC comments are starting to be a little more dovish. So, the 10-year bond yields, which are floating at 2.5%, are now pressured down to between 2.3% and 2.35%.”

Biswaroop says the exact rates matter less as individual investors buy into corporate bonds that are going to be affected more by credit risks than by interest rates.

“The individual levels do not make much of a difference unless you are trading in interest rates and taking large positions. What makes the difference is what will play out in the corporate bonds that our clients buy. Our stand is very clear: [Interest rates] are not going to have a lasting negative impact on the corporate bonds that our clients buy.”

Chang adds, “I guess part of the reason is if you are holding on to a five to eight-year US dollar corporate bond to maturity, the interest rate risk led by the movement in the yield curve for the 10-year US Treasury bonds is next to nothing.”