The Asian bond market will hold up well despite the short-term volatility arising from key global events, according to Rachana Mehta, regional co-head of fixed income at Maybank Asset Management Singapore.

Mehta says the Asian bond market will see short-term volatility with the unfolding of a series of key events around the world. These include the policy meetings of the US Federal Reserve and the Bank of Japan (BoJ) this month, which may see the Fed increasing interest rates and the BoJ easing its monetary policy further.

In Europe, Italy’s constitution referendum next month will decide the fate of Prime Minister Matteo Renzi, who announced that he would step down if the referendum does not go through. This could lead to the rise of the anti-establishment “Eurosceptic” Five Star Movement. Market players are concerned about the outcome of the referendum as it will have an impact on European Union integration.

However, Mehta says the Asian bond market will hold up as the quantitative easing programmes of the EU and Japan are expected to continue in a prolonged low-growth environment. Moreover, the yield-hunting activity of institutional and retail investors in Asia will continue.

“While these events can create volatility, I don’t think they are going to derail the Asian bond market. Even if the Fed raises its rate in September, which will create more short-term volatility, investors’ money will still come back [to Asia eventually],” she says.

Mehta, who has more than 20 years of experience in the Asian bond market, is the fund manager of Maybank Bluewaterz Total Return Bond Fund. Within Asia, she is bullish on the local currency sovereign bonds of India and Indonesia.

She says corporates and governments in Asia are buying a lot of local US dollar-denominated bonds for their investment portfolios. This has provided liquidity to the market and supported bond prices.

“Local Chinese pension funds, asset management companies and banks have been buying a lot of Chinese US dollar-denominated bonds for their portfolios since the devaluation of the renminbi last year. Japan is implementing QE and is buying Asian bonds too. The Indonesian and Philippine investors are also buying their own corporate bonds as they prefer to take on their own country’s risks [rather than buy the bonds of other countries],” she adds.

Mehta says while the default rate in the Asian corporate bond space is expected to increase next year in some sectors, it will not impact investor sentiment on the Asian bond market as a whole. “The default rate is highly likely to increase next year, but it will be very industry-specific. One thing we have noticed recently is, despite the default rate increasing in some sectors [such as oil and gas], it has not affected the whole market.”

She says this is due to the ample liquidity in the global market, which has resulted in investors hunting for yield. There has also been greater participation from private banks and sovereign funds, which are better able to distinguish quality bonds and are not easily affected by market sentiment.

“Private banks and sovereign funds globally are investing in Asia and their investment horizons are longer, especially sovereign wealth funds. It is unlike 10 years ago, when a default caused uncertainties in the market. Today, while the risk [of more defaults] is higher in some sectors, it will not affect the other sectors that much,” she adds.

Mehta says the longer-term risk to the Asian bond market is the “trade tension” and anti-globalisation sentiment brewing around the world following the Brexit vote in June and possibly after the US presidential election in November. “Trade tension is a big risk for the next two to three years, with trade agreements to be negotiated between the UK and different countries. The results of the US presidential election will also determine whether there will be more trade barriers created. This will result in weak trade and lower global growth.”

The Maybank Bluewaterz Total Return Fund feeds into the Maybank Bluewaterz Total Return Bond Fund in Singapore. The feeder fund was launched locally on

July 24 last year. As at June, the fund had generated a year-to date return of 4.15% and 4.43% since its launch.

The wholesale fund is offered to qualified investors, who are defined as having total net personal assets of more than RM3 million or its equivalent in foreign currencies.

ASIAN SOVEREIGN BONDS LOOKING ATTRACTIVE

Asian local currency sovereign bonds have begun to look attractive because of the collapse of yields in corporate bonds, says Mehta. “The valuations of Asian corporate bonds, including investment-grade and high-yield bonds, have gone up a lot [this year]. If you look at the JP Morgan Asian Corporate Bond Index, its spread has narrowed significantly against US and Europe [corporate bonds]. Despite the spread tightening in US dollar corporate bonds, we believe the hunt for yield will continue and investors will buy high-grade Asian bonds for carry purposes. We think the local currency government bonds look more attractive now and offer value.”

She is bullish on the local currency sovereign bonds of India and Indonesia as they offer investors a 6% to 7% yield, which is high compared with developed market sovereign bonds and other Asian bonds. The currencies of these countries are expected to strengthen in the medium term as economic conditions improve under the leadership of their respective governments.

“Even if the currencies of India and Indonesia weaken by 2% to 3% due to short-term volatility, we will still be able to get 3% to 4% returns for these markets due to higher yields,” she adds.

Mehta says she expects further interest rate cuts by the central banks of India and Indonesia to boost economic growth, which will continue to make their sovereign bonds compelling. The lower inflation rate in these two countries will also give their central banks room to cut interest rates.

She also favours Singapore’s 10-year sovereign bond for its good credit quality and yield of about 1.5%. “It is a triple A grade [sovereign] bond and it still gives you good risk-adjusted returns. This compares with [the 10-year] sovereign bonds of Germany and Japan [which have the same rating]. But their yields are negative.”

Mehta says the price of Singapore’s 10-year sovereign bond is expected to remain stable as the Singapore dollar has weakened against other major currencies in recent months. As such, the Monetary Authority of Singapore will not need to ease its monetary policy further to boost the country’s economic growth, which will cause the Singapore Interbank Offered Rate to go up and make the existing sovereign bond less attractive.

Despite the high valuation of Asian corporate bonds, there are still pockets of opportunities within the high-yield bond universe such as the Tier 2 capital bonds issued by the Chinese banks, says Mehta. The Tier 2 bond, also known as subordinated debt or junior debt, is a debt instrument primarily issued by banks.

In the case where the issuer of the bond defaults, Tier 2 bondholders are not be paid until the senior bondholders (Tier 1 bonds) have been paid in full. Hence, Tier 2 bondholders are offered a higher yield as they are taking on higher risk.

“The China banks’ senior bonds are very tight. But the junior bonds give you good deals, with yields at about 3.8% to 4.5%. The yields are higher because there is currently plenty of supply from Chinese banks,” says Mehta.

“While banks’ earnings are falling [in general], their yields are attractive in terms of risk-adjusted returns. The banks still play a key role in providing stability to the entire financial system.”

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