Asia Local Currency Bond Fund - Part 1

Part 1: Interview with Florencia Di Gregorio, Portfolio Manager of Asia Local Currency Bond Fund, Global Emerging Markets Team
(July 2017)

Wai Kiat: Today, we have Ms. Florencia Di Gregorio, the portfolio manager of Asia Local Currency Bond Fund, Global Emerging Markets Team at UOB Asset Management in Singapore. Florencia will explain the main characteristics of Asia Local Currency bond market.

Wai Kiat: Florencia, thank you for joining us today. As a start, when we talk about the Asia Local Currency bond market, what are we investing in?

Florencia: To invest in Asia bonds, there are two choices for investors: USD-denominated bond market and local currency-denominated bond market. Both are investing in bonds issued by either Asian governments or Asian corporates. Here, we focus on Asian Local Currency bond market.

Wai Kiat: What is the main characteristic of the Asia Local Currency bond market that differentiates it from the Asian USD-denominated bond market?

Florencia: For Asia Local Currency Bonds, the market is dominated by government / sovereign bonds of Asian countries, while the Asia USD-denominated bond market is dominated by Asian corporate bonds. As the Asia USD-denominated bond market has higher corporate exposure, the credit risk (default risk) is generally higher than the Asia Local Currency bond market which is dominated by sovereign exposure.

Wai Kiat: Talking about risk, we saw the Asian Financial Crisis (AFC) back in 1997 where countries with high debt levels were targeted – default risk for a number of Asian countries was high and many were forced to devalue their currencies. How different is it now?

Florencia: Asian fundamentals are stronger and vulnerability to external shocks is much lower than in the past. Especially when we compare with other emerging economies, Asian governments have a more solid fiscal position with relatively low indebtedness. As such, the credit risk, or risk of non-payment of the underlying bonds is very low.

Additionally, international reserves are growing and external positions are much healthier. This insulates the currencies from external shocks, reducing their fluctuations. Asian currencies have the lowest risk among Emerging Market economies.

Wai Kiat: How about liquidity? I understand that some corporate bonds do not get traded that often as supply is limited, meaning it is harder to find a buyer or seller in the market. Is it the same for Asian Local Currency government bonds?

Florencia: Not at all. Unlike other high-yielding asset classes in fixed income where liquidity can be thin, government bond markets are deeper, offering higher issue size and a more diversified investor base, hence providing good liquidity. Indeed the main holders of these Local Currency Bonds are the local institutions in each market, such as pension funds, insurance companies and banks that tend to maintain holding for longer terms. Individual investors in each one of the onshore market are also investing in the government bonds in each one of these countries. This is a very important reason why the bond’s valuation in Local Currency Markets is much more stable over time, making them safer.

Wai Kiat: That should allay concerns and build investors’ confidence in this asset class. Have we seen more interest over the years?

Florencia: Definitely. Investors’ interest in Local Currency Bonds has increased, as the search for higher-yielding bonds continue to be a focus and position in an income asset class, while the expectations of Asian currencies gaining momentum against USD and JPY have also increased.

Wai Kiat: Where’s the interest coming from? I’m sure domestic investors would be participants in the Local Currency bond market but how about foreign / international investors?

Florencia: Foreign investors have increased their participation in Asia Local Markets over the past ten years, as Asian economies have increasingly opened their borders to foreign capital. They have also focused on shifting the financing towards bonds issued in their own currency, rather than in a foreign currency such as USD. Shifting the financing towards their own currency also strengthens the ability of repayment and the resilience of the economy toward external shocks, as currencies are allowed to float and adjust the imbalances. Therefore the Asia Local Currency Bond is the growing asset class.

Wai Kiat: Are there any opportunities to invest in Asian corporate bonds denominated in local currencies or are investors only limited to sovereign bonds denominated in local currencies?

Florencia: The corporate bond market in local currencies has not reached a significant size or liquidity, even though Asia’s capital markets in this segment are better developed than other regions. However, selected Asian local markets such as Singapore or India do offer the possibility to have corporate exposure. We can take advantage of this flexibility in order to add value to the portfolio. We believe that returns can be enhanced by making use of our credit research capabilities to integrate some corporate issues when it is profitable.

Wai Kiat: What are the risks I’m exposed to when investing in Asia Local Currency Bonds?

Florencia: In the Local Currency bond market, most investors are more concerned about currency risk. The volatility is generally a measure of the risk in a market. When we compare Asian currencies’ volatility to other regions in Emerging Markets, we can also see that Asian currencies are more stable relative to European or Latin American currencies, giving a smoother return profile for investors. We see that the Asia Local Currency Market’s risk (blue) is lower than Europe (red) and Latin America (green).

The overall volatility of Asia Local Currency is also much lower when compared with Emerging Markets equities, and similar to a USD Emerging Market investment or a USD High Yield investment.

The Local Currency Market’s risk is lower than Emerging Markets equities during risk aversion periods.

Wai Kiat: What’s your view on valuations of the Asia Local Currency bond market right now? Is it attractive?

Florencia: Growth in Asia is recovering and this is supportive for currency returns, while making valuations more resilient to external shocks. Local Currency Markets are not crowded. The cumulative flows have not reached the peak, giving room for further performance.

Wai Kiat: Interesting points! With relatively low debt levels and stronger FX reserves, Asian countries appear better equipped with defense tools now compared to the Asian Financial Crisis. Also, the risk-reward looks really attractive given that an investor will receive stable income with lower volatility than equities. More importantly, with improving fundamentals, the potential for growth in this asset class looks immense.

To help investors understand more about the attractiveness of this asset class, I will be looking forward to seeing you for our next interview session.

Thank you once again.