Fund flows into Asian fixed income will continue to be robust

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Asian bond markets are growing rapidly as Asian borrowers switch away from short-term bank loans towards longer-term debt financing. Koh Liang Choon, head of DBS Asset Management’s fixed income/currency team, shared his views with Asia Asset Management on the current state of the market and where it is heading.

AAM: How is your Asia bond portfolio positioned and have you altered it at all in the last few months?

Koh Liang Choon: In the face of rising inflationary concerns in Asia, we are currently strategically defensive on the duration of most of our Asian fixed income portfolios. We have started to invest in inflation-linked bonds, which act as a hedge against potential higher inflation upticks going forward. In terms of changes to country allocations, we have added CNH bonds (Chinese yuan freely traded on the Hong Kong market) to our portfolio to leverage on the potential of yuan appreciation.

How much liquidity is there in Asian fixed income markets at the moment?

The depth of the Asian fixed income market is increasing with total local currency bonds outstanding doubling from US$2.6 trillion in 2006 to US$5.2 trillion in 2010. Also, market makers and primary dealers in the Asian fixed income market have also been increasing; this lends support to the liquidity of the market and narrows the bid-ask spreads of bond prices. In terms of average daily trading volume, the Singapore government securities average approximately S$400 million (US$313 million) to S$600 million per day, Indonesia government bonds average about 4 trillion rupiahs (US$456 million) to 5 trillion per day and Malaysia government securities average about 7 billion ringgits (US$2.29 billion) to 8 billion per day. (Source: ADB, Barclays, Dec 2010)

What is your outlook for the asset class?

With improved fiscal positions, strong current account and FX reserves, we continue to be optimistic on Asian fixed income, which has consistently proved to be a valuable standalone asset class that provides great diversification and risk/returns to global investors.

Are you finding increasing issuance from governments? How could this affect Asian currencies?

Yes, we have been seeing increasing issuances from Asian governments but we do not see the current pace of issuances as unsustainable. This is especially true when in comparison with the US and Japan with debt to GDP at 59% and 225% respectively, while countries like Indonesia and Korea have much lower debt to GDP at 26.4% and 23.7% respectively. And with the improving level of debt ratios, we believe that this is positive for Asian bonds and currencies. (Source: CIA)

Which single holding has been the best contributor to performance of the fund over the past 12 months?

Our holdings in Indonesian government bonds had benefitted our portfolios the most on a total return basis in the past year. On the back of strong commodities’ performance and attractive yields, the Indonesia rupiah had appreciated 5.6% versus the US dollar in 2010. We believe the positive trend will continue as Bank Indonesia is becoming more permissive of the currency’s strength to rein in inflationary pressures. The Indonesia recap bonds had also performed well in 2010 as the benchmark curve bull-flattened with ten-year yields lower by about 3.3%. This year however, we are more watchful of Indonesian bonds, as inflation pressures rise and foreign holdings of bonds become prominent. (Source: Bloomberg, Dec 2010)

Now that markets look more normal again, where do you think are the best opportunities in Asian fixed income?

Asia central banks are likely to normalise interest rates further this year in tandem with concerns of rising inflation – this underscores the importance of being defensive in our strategy on portfolio duration. However, we think that there is potential for Asian currencies to strengthen as central banks are more allowing of appreciation in their currencies in order to rein in imported inflation. This is already evident as we have already seen currencies like the Singapore dollar, Malaysian ringgit and Indonesian rupiah reaching year-to-date highs against the US dollar.

What is the biggest risk or opportunity you see in the portfolio?

With the recent unrest in the MENA (Middle East and North Africa), the biggest risk to our minds is that the unrest contagion spreads to Saudi Arabia, the region’s biggest oil producing country. Under such a scenario, there is an increased risk of a supply-led oil shock that will create problems for Asia, which is generally very oil dependent. Current account balances will likely deteriorate and inflationary pressures will worsen, which are both negative to FX and bond markets. In the worst case scenario, global growth will slow down, raising the odds of a double dip recession. That said; this is not our base case scenario but we are attentive to developments in MENA and mindful of all risks involved should our worst fears materialise.

* Mr. Koh expressed these views prior to the events currently taking place in Japan.

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