Institutional investors holding firm on Asian credits, says Schroders

19 November 2013   Category: News, Asia, Global   By Hui Ching-hoo

Schroders believes institutional investors will remain confident on Asian credits despite lingering uncertainty following the steady outflow from Asian bonds between May and August this year with adjustments to US monetary and fiscal measures.

Rajeev De Mello, head of Asian fixed income at Schroders tells Asia Asset Management that the capital flows from Western institutional investors into Asian credits actually remained positive during the period due to the low-yield environment in the US and Europe. The recorded capital outflows from the credit market were mainly sourced from US and Europe mutual funds rather than the institutional side, he notes.

The institutional wager on Asian bonds is justified given that the yield spread between Asian bonds and US and Europe fixed income has widened to as much as 300 basis points. Investors can further capitalise on the expected long-term appreciation of the Asian currencies to beef up those returns.

“The capital flows are partly driven by institutional investors’ long-term investment strategies,” he says. “For example, life insurance companies and pension funds need to allocate a certain proportion of their assets to Asian fixed income to build a balanced portfolio.”

“That said, institutional investors will not aggressively increase their exposure to the asset class any time soon either. Generally, they are sitting on the sidelines until yields returns to a higher level.”

Mr. De Mello reveals that his Asian bond portfolio comprises a significant proportion of corporate high yield and convertible bonds; the former offer some decent carry, while the latter are undervalued he asserts.

Even though the portfolio has increased its proportion of lower-rated corporate bonds, its overall credit rating remains investment grade.

Despite the asset rotation theme that has come into play against a backdrop of the QE tapering, Mr. De Mello believes it is mainly taking place in a shift from cash to equities. He plays down the threat of a swing from fixed income to equities, saying central banks still have strong demand for fixed income including Asian credits because they want to diversify their holding from treasuries: “We’ve seen that several central banks, such as Bank of Japan, are buying back bonds aggressively.”

Overall, Mr. De Mello identifies higher yields, lower sovereign risk, diversification of bond portfolio, lower sensitivity to higher US yields, and currency appreciation expectations as the key investment drivers for Asian bonds.

He thinks the US Fed will not end the ‘zero interest’ policy until the second half of 2015, in view of the current US economic condition: “I think the US Fed wants to signal to the market that it will maintain a zero interest rate for a long time, even as it slows down bond purchases.”