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Multi-dimension portfolio diversification with Asian local currency bonds

State Street Global Advisors discusses how Asian fixed income investments offer efficient returns relative to risk.

As the bonds of troubled developed nations lose their risk-free aura, investors are beginning to re-evaluate different asset classes and looking to exposures such as more stable Asian sovereigns to help them diversify their portfolios.

Evolution of Asian local-currency debt
In the past, allocations to Asian fixed income were limited to domestic institutional investors such as insurance companies and banks which typically hold their investments to maturity. Global investor allocation was not common on concerns over liquidity, accessibility and credit quality.

But ongoing issuances in the region and strategic development initiatives by Asian regulators and market participants have caused local debt markets to evolve. The market capitalisation of Asia ex-Japan local-currency debt has almost tripled in the past five years to over $5.8 trillion, or approximately 8% of the world’s bond market. Along with growth comes improved liquidity, which enables access by domestic and international investors alike.

Favourable economic growth is also spurring bond market development. Asian economies are exhibiting stronger growth than more developed nations, buoyed by favourable demographics, strengthening domestic demand and increased global competitiveness. In addition, their manufacturing and export-driven economies support increasingly robust employment and consumer spending. Although exports to traditional markets such as the US and Europe is dampened due to economic downturn, the increasing growth and collaboration in intraregional and the South-South trade help Asian countries to expand their markets and less reliant on the developed markets.

Figure 1: Real GDP growth

Structural reforms and prudent policies have led to greater stability and sustained growth even during troughs in the global economic cycle. The balance sheets of many Asian countries have also improved after the Asian financial crisis and now hold substantial reserves.

As a result, many Asian governments with lower credit ratings see their credit profiles improving and expect to earn rating upgrades. By comparison, many developed countries are facing large public deficits and unemployment amidst Europe’s sovereign debt crisis, making Asian countries’ debt-to-GDP ratios much more attractive (Figure 3).

Figure 2: Many Asian markets have greater room to improve their credit profiles

Source: GDP: IMF estimates, World Economic Outlook Database April 2012. Yields and Credit Rating: Bloomberg, Highest Local Currency Long Term Debt Rating (S&P, Moody’s and Fitch), as of August 1, 2012


Figure 3: Debt-to-GDP Ratio of Asian Markets and developed markets

Source: IMF, World Economic Outlook Database, April 2012 (2015 data are projections)


With the liberalisation of the local bond market, plus stronger fundamentals, policies and creditworthiness, investors are increasingly eyeing this regional asset class for higher yields, potential currency appreciation, and portfolio diversification.

The annualised return for Asian bonds in the past 10 years is about 8%, compared with 5.1% for duration-adjusted US bonds, but the volatility of Asian bonds is only 1.8% higher.

Figure 4: Rolling one-year returns on Asian bonds and comparable US duration-adjusted bonds

Source: Citigroup Government Bond Indices, Markit iBoxx ABF Pan-Asia Index and SSGA; index data from January 2001 to June 2012 Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. Past performance is not a guarantee of future results.


Asian bonds are also expected to generate greater returns from currency appreciation. Structural trade surpluses and growth differentials with industrialised nations are expected to exert upward pressure on Asian currencies over the medium- to long-term. Historically, currencies have contributed more than 30% of the total return from Asian local currency bond returns.

Figure 5: Rolling one-year returns on Asian local currency bonds (unhedged)

Source: Markit iBoxx ABF Pan-Asia Index as of June 30, 2012 (index data from January 2001).Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. Past performance is not a guarantee of future results.


Multi-dimensional portfolio diversification benefits
Asian fixed income investments can provide significant diversification benefits to multi-asset class portfolios. Because interest rates vary between countries, an allocation to emerging Asian bonds can temper the impact of downturns in developed markets. The asset class comparison below suggests Asian local currency bonds provide most efficient returns relative to risk.

Figure 6: Diversification benefits of Asian local currency bonds

Source: Calculated by SSgA with data from Markit, J.P. Morgan, Citigroup and Bloomberg for July 2002 to June 2012 period. Indices used (from left to right): Markit iBoxx ABF Pan-Asia Index, J.P. Morgan GBI-EMU Index, Citigroup US Treasury Index, MSCI EM and S&P 500. Note: Returns are in US dollar terms, unhedged. Risk free rate used for Sharpe Ratio calculations is based on the J.P. Morgan one-month Libor Index returns. For the period June 30, 2002 to June 30, 2012.


Easier access with fixed income ETPs
Investors continue to embrace ETPs (Exchange Traded Products) to implement their investment strategies. The liquidity and tradability of ETPs allow tactical shifts and immediate rebalancing. Fixed income investors found these features to be particularly important in today’s volatile and uncertain market, where they need to act promptly on events.

Fueled by ongoing adoption by investors and flight-to-safety trends, global fixed income ETPs saw over $40 billion in net new assets year to date. This is more than twice the inflows during the first half of 2011 and 40% of all ETP inflows. In Asia, fixed income ETPs are currently a $5.6 billion market, representing about 5% of the entire APAC ETP market. The majority of fixed income ETPs asset reside in the ABF Pan Asia Bond Index Fund, which invests in sovereign debts of eight Asian economies. It is the first and largest fixed income ETP in Asia, and consistent inflows have pushed its total assets to $3 billion recently, showing investor demand for the asset class and investing via ETPs.


The trust’s prospectus may be obtained upon request from State Street Global Advisors Singapore Limited and can be downloaded from the Trust’s website

About ABF Pan Asia Bond Index FundABF Pan Asia Bond Index Fund (“PAIF”) is an exchange traded bond fund which seeks to provide investment returns that corresponds closely to the total return of the Markit iBoxx ABF Pan-Asia Index (“Index”), before fees and expenses, and its return may deviate from that of the Index.

PAIF primarily invests in local currency government and quasi-government bonds in eight Asian markets, comprising of China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand.

Investment involves risks, including risks of exposure to bonds in both developed and emerging Asia markets. Investors may lose part or all of their investments.

The trading price of PAIF may differ from the underlying net asset value per share.

PAIF may not be suitable for all investors. Investors should not invest based on this marketing material only. Investors should read the PAIF’s prospectus, including the risk factors, take into consideration of the product features, their own investment objectives, risk tolerance level etc and seek independent financial and professional advices as appropriate prior to make any investment.

Important informationThis material is for your private information. The views expressed in this material are the views of SSgA Asian Fixed Income Team through the period of July, 2012 and are subject to change based on market and other conditions

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information.

PAIF is an authorised unit trust in Hong Kong and Singapore only and it is listed on the Stock Exchange of Hong Kong (2821 HK) and cross-listed on the Tokyo Stock Exchange (1349 JP). Authorisation does not imply official recommendation. No action has been taken to permit an offering of units in PAIF other than those listed above. Nothing contained here constitutes investment advice or should be relied on as such. Past performance of PAIF is not necessarily indicative of its future performance. The prospectus for PAIF is available and may be obtained from State Street Global Advisors Singapore Limited (the “Manager”) (Singapore Company Registration number: 200002719D) and authorised participants. The value of PAIF and the income from them, if any, may fall or rise. The semi-annual distributions are dependent on PAIF’s performance and are not guaranteed. Redemption of PAIF’s units could only be executed in substantial size through designated dealers and the listing of PAIF on the stock exchanges do not guarantee a liquid market for the units, and PAIF may be delisted from the stock exchanges. PAIF may use or invest in financial derivatives.

This document is issued by State Street Global Advisors Singapore Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong (“SFC”).

© 2012 State Street Corporation — All rights reserved

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