The New Normal: Navigating the current environment with high quality Asian Bonds By Maybank Asset Management 06 Oct 2020
Maybank Asset Management Singapore has scored significant wins at the 2020 Refiniv Lipper Funds Awards and 2020 Citywire Asia Awards. Its Maybank Asian Income Fund won Best Fund, Bond Global USD over 3 years and over 5 years (Refiniv Lipper) and Best Fund Group 2020 – Bonds Asia Pacific Hard Currency (Citywire). Judy Leong, who is the key portfolio manager for this fund, also took home the award for Best Fund Manager 2020 Singapore in the Bonds – Asia Pacific Hard Currency from Citywire.
2020 is a year where the global economy has been brought down to its knees by the emergence of the coronavirus and unprecedented measures taken by local governments to curb its spread. As the world pursues to contain the virus and support the economies, we have to recognize that both businesses and investors alike will have to adapt to a new norm. This new norm presents both opportunities and challenges.
Judy and her team will be giving us insights on the Asia bond market and how their investment approach seeks to navigate and identify such opportunities against this COVID-19 environment.
Asia Fixed Income Market Review: What are the key highlights in 3Q2020? Why did markets reacted the way it did?
Asia USD Fixed Income continued its strong recovery from 2Q2020 into 3Q2020 but lost some steam in September. For 3Q2020, the JP Morgan Asia Credit Index delivered about 2% in total returns, with 1.90% from investment grade and 2.3% from non-investment grade bonds. For YTD ending September, JP Morgan Asia Credit Index was up 4.2% with investment grade bonds driving majority of the returns +5.4% while non-investment grade bonds turned in meagre returns less than 0.5%.
Source: Bloomberg, September 2020 Bond markets started experiencing volatility from the second half of August onwards. Markets were disappointed on the lack of further stimulus from the government as well as a lack of evidence that the US Federal Reserve would be implementing any yield curve control. Long end Treasuries sold off 20 basis points and credit spreads widened. At the September Jackson Hole meeting, the Federal Reserve announced the change from inflation target of 2% to targeting average inflation of 2%. This meant that the Fed is willing tolerate higher inflation in future. The Fed Dot Plot also suggested that there would be no interest rate hike until end of FY2023. While this anchored short end rates, long end bonds continued to trade weak as markets focused on inflation fears. The sell-off further escalated in the last week of September when a letter from China Evergrande to Guangdong government dated 24th August was circulated on Bloomberg. In that letter, Evergrande warned of potential default of the group that could roil the country’s financial system unless regulators approve its long awaited backdoor listing in Shenzhen. Evergrande equity and bonds tanked over 10% and these also caused widespread weakness in China property bonds and Asian high yield bonds. Adding to the negative sentiment was the downgrade of Sri Lanka sovereign bonds from B2 to Caa1 end September.
4Q2020 Asia Ex-Japan Fixed Income Outlook As we enter into 4Q2020, we can identify several key political risks that will cause volatility to financial markets. We have the continued US-China cold war, the upcoming US Presidential Elections as well as the risk of a no-deal Brexit by end 2020. This is on top of the pandemic challenge that we are still facing globally and whether we can continue to open the economy gradually as we enter into winter season for US and Europe.
In the face of these risks that occupy our headlines and emails very other day, it is very easy to forget that there are some basic fundamentals that anchor well for bond investments currently. First, bond returns are generally affected mainly from interest rates and credit spreads. Due to the likely prolonged weakness in growth caused by the global pandemic lockdown, the US Federal Reserve has committed to keeping interest rates low for the next three years till end FY2023. As for inflation, we believe that the risks are low given that the inflation pressure some countries had experienced in the past few months were due to supply chain disruption from the global lockdown and not from demand pressure. With increasing job losses and uncertainty on when economies can fully re-open, we are not confident of seeing increased consumer spending any time soon. Low interest rates and low inflation would be positive for bond investments.
The second key risk that erodes bond returns is default risks. Given that we are in a global recession this year, international rating agency Moody’s has predicted during April that the default rate for Asia would increase to 6% for FY2020 from below 2% previously. They maintained their forecast for Asia in an update in August, which is lower versus forecast default rate of 13% for US and 7% for Europe. While we agree that default rates will be higher, we can manage this risk by investing in higher rated bonds and avoiding weak rated bonds. Majority of the defaults occur in single B rated issuers or below. In addition, central banks in US, Europe and India have rolled out supportive financing programs such as bond purchasing programs and government standby guarantees for loans to private companies. These programs have injected the much needed liquidity boost to private businesses during this highly stressful period. Moody’s monitors liquidity stress as one of the main triggers for defaults. While liquidity stress has increased for Asia during 2Q2020, they observed that the Asian Liquidity Stress Indicator “ALSI” (dark green line) peaked in May and has been on a down trend since June through August. With liquidity stress diminishing as economies reopen, default rates (light green) may have peaked and trend lower going forward.
The third point is that while default rates are expected to be higher, we are being compensated to manage this risk. Bond spreads are currently wider than the five year average. As we get past this quarter of US Presidential Elections and Brexit risks, and as economies continue to re-open more next year with hopefully a successful vaccine and treatment in place, credit spreads should tighten in again towards the average and cause bond prices to rally. Source: Bloomberg, September 2020
Relative to US and Europe non-investment grade bonds “HY – High Yield”, Asia HY are currently trading at higher yields with lower default rates as predicted by Moody’s highlighted under the second key risk. Therefore under a risk-adjusted basis, we are being paid more to take on risk in Asian USD credit bonds. Source: Morgan Stanley: Asia Credit QE Survival Guide, 8 Sept 2020.
In conclusion, it has been an eventful year and we expect higher volatility going into the last quarter of FY2020. However we do not expect to revisit the magnitude of sell-offs experienced in March this year due to the global COVID-19 lockdown. The macro fundamentals are supportive for bond investments for the next few years and we continue to expect 4% to 5% returns annualised, which is attractive for investors in the current low rate environment. Asian bonds are also offering higher yields for lower expected default rates relative to US and Europe. Therefore, we encourage Investors to remain invested as we expect a more stable environment in FY2021.
How has the Maybank Asian Income Fund performed this year with the COVID-19 situation? The Maybank Asian Income fund USD retail class returned 3.83% year-to-date (YTD) ending August 2020. The fund, like all other bond funds, was negatively impacted by the March sell-off due to global lockdown but recovered back during the second and third quarters of 2020. As of 31 August 2020, the fund has delivered 5.65% annualised returns since inception date November 2014, outperforming the benchmark JP Morgan Asia Credit Index (JACI) by 56bps.
Why invest in the Maybank Asian Income Fund? The Fund is an actively managed, award winning fund with proven track record. The fund manager actively seeks to outperform the wider fixed income market by holding an optimized portfolio across country, rating and duration. The Fund diversifies its income yielding assets across Asia, encompassing government, corporate and high yield bonds. It also aims to pay out potential monthly distributions.
Maybank Asian Income Fund: Portfolio Positioning With interest rates staying lower for much longer, we remain positive on bond investments for the next two years. While 4Q2020 is expected to be volatile, we have to look through this quarter into the year FY2021. We continue to add to bond investments up to ten years maturity. While we do not see risk of inflation pressures, we will avoid adding the ultra-long end bonds for now as technicals could overwhelm fundamentals. Lower interest rates is positive for corporates and we continue to favour corporate bonds over Treasuries. As mentioned earlier in our outlook, liquidity stress peaked in May and has been improving as economies re-open. Hence we feel that there is opportunity for credit spreads to tighten going into FY2021 which will benefit corporate bonds.
We reduced portfolio duration to 4 years from 5 years by selling the long end and trimmed some high yield. We have also increased cash level from 5% to 15% to stay more nimble going into a more volatile 4Q2020. When markets stabilize in the near future, we will have more cash to deploy.
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Information is correct as of 06/10/2020. |