Heda Bayron: 

Welcome to the PineBridge Investments podcast. I’m Heda Bayron, content manager for Asia at PineBridge. Today we’ll discuss Asia investment grade bonds – a trillion-dollar market that is attracting rising interest from global investors. Our guest, Omar Slim, senior portfolio manager, fixed income based in Singapore, will help us understand what drives this market, how to navigate opportunities and risks, as well as the latest trends impacting the market. Welcome, Omar.

Omar Slim: 

It’s good to be here, Heda. Thank you.

Heda Bayron: 

Let’s start with an overview of the Asia investment grade market or Asia IG. How does the Asia IG universe compare with US or Europe IG? And how has this market performed in the past?

Omar Slim: 

I think the first thing to mention is that when we talk about Asia IG in this particular context we are talking about the US dollar-denominated market. As you know, within Asia, there are local currency markets as well as US dollar markets, so in this particular context we are referring to the US dollar-denominated market. So that market in terms of size it’s smaller than the US or the European market although it’s quite a large market with a market cap of higher than one trillion, about 1.1 trillion or a bit less than that now. This is a market that has been growing steadily over the past few years so we get over 250 billion dollars of gross supply a year.

In terms of the composition of the market, unsurprisingly, China has a large weight given its large weighting within the region. So China represents about half of the market or more precisely about 49%. The other Asian countries that are well represented include Indonesia, Korea, India, the Philippines, Singapore, Malaysia, and Thailand. In terms of industries, this market is dominated by three really large segments. The first one would be the financials, in particular the banks. The second would be the sovereign bonds, in particular here we have issuances from Indonesia as well as the Philippines. We do have some issuances from other countries such as China and Korea, except that they tend to issue much less frequently. And the third segment would be what we call the quasi sovereign, the government-related entities. That’s really a particularity of this market where we have quite a few government-related entities that are frequent and large issuers, including from China but also other market such as Indonesia, India the Philippines, Singapore, and other markets as well. The average rating of the market is single A minus and this has been steady over the past few years.

In terms of the market performance, this market has been performing quite well in the past few years particularly when one looks at risk-adjusted performance so the volatility of this market has been quite subdued. And that has been interesting to watch particularly because this market has been tested over the past few years, whether its external shocks, essentially monetary policy shocks from outside of Asia, or unforeseen events or certain political tensions that, for instance, lead to trade tensions between the US and China or some of the internal shocks within the market, which we can talk about later, for instance some as the volatility were seeking in terms of the real estate market. But throughout these shocks one of things that we have seen and we think this will continue to be the case is that this market has volatility that is relatively quite subdued.

Heda Bayron: 

So what makes this market attractive? Yield-wise, for instance, how does it compare?

Omar Slim: 

So when talking with clients and prospects, particularly when talking with non-Asia based clients, I think there are a few things that jump out essentially. The first one, as you alluded in your question, from a valuation perspective, this market particularly when compared to similar markets -- for instance the US IG market with same currency, same kind of credit quality -- this market has slightly better yields. But importantly it has yield differential with much lower duration and this is important particularly in an environment where we see rising rates. So duration, for instance, for the Asia IG market is about five, five and a half years; for the US IG market, it should be higher than 8 years. So there is a market that has more interesting valuations while being less interest rate sensitive. And I think this is quite interesting as a feature for this market. The second thing I would highlight is what we broadly call technical factors, and this is something not often discussed but we think is a very important anchor for this market, which might explain the volatility which has been relatively low. And this is the fact that this market is essentially seeing supply, but from a net supply perspective --so essentially gross supply minus the coupon payments and the maturing bonds-- it has been relatively low. So essentially we have a region that has a home bias. Essentially a lot of the Asian buyers have a home bias in terms of trying to purchase Asian bonds and a growing money pool that’s chasing supply which is relatively limited. So this is a strong anchor for the market and we think this dynamic will continue for the foreseeable future which has an impact on the volatility of this asset class.

Heda Bayron: 

How are currently positioned in this market, given the focus on monetary tightening and rate hikes? How do you mitigate such risks and where are the best opportunities?

Omar Slim: 

Right, so for your first question, the market itself has lower duration so essentially it is less sensitive to interest rates risk. It’s not not sensitive to interest rate risk, it is, but less so than some of the other markets. In addition to that we try to manage duration through a number of tools whether its bond selection or through US Treasury futures and other tools where our strategies allow us to do so and most of them do. And this would be a good hedge given that it’s US dollar denominated and trades off the US Treasures so this is essentially a clean hedge. Right now, for instance, we have been cautious on duration because of the dynamic that you described. In terms of the opportunities we do see opportunities particularly within the corporate credit space and it tends to be very bottom up in terms of the research that we do so it’s harder to have a broad-brush statement of what we like in terms of countries or industries. But broadly we like some of the large financials within Asia, we like some of the government-related entities that have interesting valuation. We are more cautious on certain segment of the Chinese space and have been for a while, particularly given some of the changes in terms of the Chinese policy. And we like certain names in the Indian space that have been benefiting from positive fundamental trends.

Heda Bayron: 

So earlier you mentioned some attractive features of the asset class such as yield, technicals, strong demand that underpins the market, but the foreign ownership of Asia bonds in general s still relatively low? What are the common hurdles and how can they be overcome?

Omar Slim: 

That’s an interesting question and, again, I would like to differentiate here between the ownership of the local currency market and the ownership of the hard currency market or the market we are referring to here. So if we’re talking about the US dollar market is relatively low so on average I would say it’s a quarter to one third foreign owned or non-Asia owned and there are a few reasons for that. One of them is the fact that Asian buyers are dominating this so it’s not the lack of desire to be included in those deals, it’s just that a lot of the interest is being overwhelmed by Asian buyers. So for instance, just to give you an example without being overly technical, so there are quite a few Asia-based issuers that don’t really need to go for instance into the US market or what we call the (Rule) 144A market so they stay in what we call the Reg(ulation) S market, which essentially targeting the non-US based investors because they feel that they could essentially issue what they need without going into the US market which has additional regulation requirements and so on. So that’s one important factor. The other factor is that the non-Asian investors are still exploring Asia, increasingly so in the sense that more of the non-Asian investors particularly out of Europe are exploring Asia and locating into Asia and I think this is one of the trends that we’ve been seeing. But it’s not as prevalent as perhaps it could be. So one of the things that we have seen is for the global investors that do not want to have local currency risk or to have a lower credit quality allocation the Asia IG market is a natural and easy first step for them to make.

Heda Bayron: 

You mentioned that China is a key component of the market. Markets have been watching closely the developments there especially after the regulatory changes late last year, the credit troubles, and the possibility of an economic slowdown this year. How would these developments impact Asia IG?

Omar Slim: 

It has a large impact on Asia IG, perhaps not as large as the Asia high yield market, but it has a large impact on Asia IG in particularly given not only the weight of China in the market but the impact that China probably has on the region. I would say two things: one, in particular on investing in China one really needs to understand the direction of policy. Understanding policy is key in investing in China even more so than, for instance, having an opinion of GDP at 5% or 5.5% and going into the details of this. We think that it’s really policy that drives the market’s performance as opposed to the nitty gritty of the economic data given how present government and government-related entities are in the Chinese economy. So it is critical to understand the direction of Chinese policy and invest accordingly. So the second thing I would say is that there has been an important shift in terms of Chinese policy. This is something that the Chinese policy makers have been consistently saying and more recently putting into action. And this is that the Chinese sovereign support will be at the very least less forthcoming in terms of trying to bailout Chinese issuers or Chinese companies. So this has important ramifications in particular for the Asia high yield segment but also for the Asia IG segment. It is important to integrate it firmly into one’s investment thesis, otherwise the investor should no longer invest thinking that everything’s going to be bailed out by the Chinese government. So for instance, there are some segments that Chinese policy makers are supportive of, others they are less supportive of and that is something that we integrated in terms of our positioning. We have been a bit more cautious in terms of China so right now underweight in terms of China and our credit selection is actually quite selective in terms of the exposure that we take within China.

Heda Bayron: 

Speaking of credit selection, can you walk us through your credit selection process. How much macro goes into your process vs. bottom up?

Omar Slim: 

So our process has this simultaneous top-down decision-making process as well as bottom up for Asia IG. Credit selection tends to carry a larger weight in terms of diving alpha or driving outperformance. I would say it would be about one third in terms of the macro positioning across the curve, and about more than to third in terms of credit selection. So credit selection is critically important and has been driving most of the performance for the strategies. And the credit selection process that we have, and this is a process that we take particular pride in, is essentially centered around having opinions across three dimensions if you wish. The first one is having opinion in terms fundamentals, second one is valuations and third on technical. On fundamentals, we have what we call credit categorization, which our credit researchers essentially deliver. This is a fundamental research driven process. The credit categorization is a reflection of the level of conviction that we have and the trend line of the credit metrics as well as the visibility that we have in terms of the credit issuers. Valuations is more of an opinion in terms of trying to assess value, so we have things like relative value ranking across every bond and technical are essentially factors that do have impact in terms of bonds but we couldn’t categorize as fundamentals or valuations. So these could be factors such as broad is the investor base, is it a bond that will go into a number of indices, is it a bond that will be traded and so on and so forth.

Heda Bayron: 

Omar, you’ve been in Asia for more than a decade now. What do you think are the advantages of being a fixed income manager on the ground in Asia?

Omar Slim: 

I think being in Asia has its benefits, but it’s not to say that investing from outside of Asia is not feasible. But I think being in Asia has its benefits. This is a market that is now large enough to justify having on-the-ground presence and this is something that we have. So from the very basic from being in the same time zone to the more nuanced, which is essentially having researchers ad well as people on the ground that speak the language and connected in terms of the local media, the local connections, the counterparties, as well as the ability to meet companies, having what we call internally as touchpoints, so this is essentially having a regular dialogue with issuers on the credit metrics but also in terms of engagement particularly when it comes to ESG, I think these are things that are made much easier being in Asia as opposed to being in other places. And I think more and more managers are realizing that. And I think given that the market is large enough and growing, and in particular given the fact that some of the global allocators are allocating what we think would be allocation that would be sticky, I think it’s important to have that on the ground feel, on the ground research capabilities.

Heda Bayron: 

Thank you, Omar, for this interesting discussion. And thank you everyone for listening. We hope that you will join us for future episodes of our podcast. For more economic and investing insights, please visit our website, pinebridge.com.

ENDS