Short Duration Asian Bonds: Cutting a path through the investment fog

It is hard to remember a time when investors haven’t been facing relatively eventful markets, for one reason or another. From oil prices to interest rates to economic growth, it is essential amid both bullish and bearish sentiment to filter out the ‘noise’ and take tangible steps to tackle uncertainty.

In doing this, it is generally considered wise for investors to have an appropriately balanced portfolio, tailored to their risk appetite – which also boasts some resilience.

This is easier said than done, especially since even so-called safe havens assets like gold can be prone to wild swings in price, just as markets saw in early 2020.

However, an option to potentially consider as part of a diversified investment portfolio are short duration Asian bonds strategies.

These provide certain benefits based on three key traits that are generally present in these types of strategies:

  • Lower portfolio volatility

  • Generally, relatively high liquidity during stressed periods

  • A buffer against the interest rate risks while focusing on income and selective credit

This combination of features takes away a lot of the inevitable uncertainty about how markets will move and the actions of central banks in response.

More specifically, short duration bonds are, in general, less sensitive to rate and credit spread movements compared with debt that has a longer duration.

Plus, the price of bonds nearer maturity tends to be closer to par than longer duration bonds. This is due to an ability to estimate coupon and capital payments from short duration bonds with greater certainty than bonds with longer durations – implying lower volatility in returns compared with the broader market.

Rallying around rising rates

While the nature of short duration bonds is to systematically reallocate risk budget from interest rate risk to credit risk – a risk that is easier to manage with active credit analysis – a focus on short duration Asian bonds will become even more meaningful for portfolios once the time comes when rates start to rise again.

Given that interest rates and bond prices tend to move in opposite directions, higher rates could have an adverse impact on bond prices. Such an environment is challenging for long duration bonds, which might face significant losses.

By contrast, a short duration strategy offers two clear advantages:

  • The potential to outperform since cash flows from maturing bonds can be reinvested at higher rates in the market

  • The potential ability to help preserve capital

Boosting liquidity

At the same time, having a larger percentage of an overall portfolio in bonds that mature regularly creates potential for getting regular cashflows to the portfolio.

This might enable investors to avoid forced selling, especially during a stressed environment.

It should also create an ability to ensure a higher reinvestment rate, with the potential to seize investment opportunities arising from rates once they rise.

At the same time, a short duration strategy can reduce transaction costs by holding bonds until maturity – a situation that might also improve returns over the long term.

Asia’s value-add

The allure of Asian credit makes short duration bonds potentially even more compelling within investor portfolios.

For example, at over US$1 trillion in market size[1], the US dollar Asian bond market provides diversity across a number of countries and industries.

Further, the possible long-term opportunity this asset class creates stems from the credit ratings of Asian issuers being, on average, higher than those of their peers. This reflects the structurally lower default rates across both investment grade and high yield names.

With lower volatility and strong returns in comparison with US and European equivalents[2], Asian investment-grade bonds offer an attractive risk-return profile.

Read More: Asian credit in context: A new challenge awaits

Take a look at the appeal of Chinese property, for instance – one of the key sectors within Asia’s investible credit universe.

This has been notably robust during the current and difficult environment, bucking the trend of a lean time for global bond issuance in early 2020, with Chinese developers issuing billions of dollars in debt  (see box).

Chinese property: Promising amid uncertainty 
Despite the impact of lower sales on both liquidity and credit profiles on ratings outlooks for Chinese developers, the outlook for this sector is far from gloomy.

To combat vulnerability, analysis from S&P Global Ratings suggests some developers have amassed or are working hard to boost their subscription sales through virtual or alternative channels. Such figures will indicate the potential conversion into genuine cash inflow. According to data provider China Real Estate Information Corp (CRIC), March sales has recovered to 60-70% level comparing to same period in last year.[3] In addition, the 2019 full-year results have shown a general deleveraging trend especially for large-sized developers, which provides good starting point for 2020.

Other signs are promising from liquidity perspective. For example, Chinese property developers have been quick to capitalise on lower borrowing costs in onshore bond market to ease the short-term liquidity pressure.   According to CRIC, in the week of 5 March just over US$4 billion worth of debt was issued by these companies in onshore bond market, up 38.4% from the previous week.[4]

This was supported by factors such as a hunt by global investors for returns amid lower US Treasury yields. In addition, the Chinese government’s injection of liquidity into the financial system helped to dispel some investor concerns over potential defaults.

Adding more portfolio clarity

Supporting the short duration story are the multiple ways to put it into practice. From high yield to inflation, and from emerging markets to Asian credit, investors can get various exposure to short duration bonds depending on their investment need – whether this is downside mitigation, diversification or carry.

The attraction of Asian credit, in particular, is based on a mix of factors. These include the region’s higher growth potential in a world of sluggish recovery, higher yields and spreads in a world of zero, or negative, interest rates, as well as an expanding and diversifying debt issuance.

The upshot is stable income generation while mitigating volatility, derived from the goal of capturing a significant part of the market yield with less volatile returns than the all-maturities market.

The importance of this outcome is heightened since, from one day to the next – during any market environment – nobody knows where the markets are heading. In line with this, consensus over whether risk should be on or off is non-existent. In fact, making a call anywhere along the risk spectrum is risky.

Ultimately, therefore, to help give investors peace of mind, a short duration Asian bond strategy may be worth more than its weight in gold.

[1] J.P. Morgan Asia Credit Index

[2] Bloomberg. rolling five-year data, as of 31 December 2019

[3] China Real Estate Information Corp, as of 31 March 2020

[4] https://www.caixinglobal.com/2020-03-14/property-developers-increase-borrowing-as-covid-19-slows-sales-101528369.html