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The Case for Asian Local Currency Bonds January 2021 Schroders As Your Partner in Asian Bonds

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The Case for Asian Local Currency Bonds January 2021 Schroders As Your Partner in Asian Bonds Marketing material for professional investors and advisers only The Case for Asian local currency bonds January 2021 Schroders as your partner in Asian bonds At a glance Challenges in a low rate environment for As interest rates have fallen to historic lows over fixed income investors the past year, we explore which segments of the As global interest rates plunged to historic lows fixed income market could still offer investors following the pandemic, it has become increasingly the potential for attractive income and returns. challenging for investors to find opportunities in the We first review the performance of global fixed fixed income market that could still provide an income market over the past 15 years and show adequate level of income as well as the potential for that Asian bonds have performed well, downside protection. In the past, investors could particularly against other emerging markets. look across the spectrum of fixed income investments We then analyse some potential drivers for this to find value and opportunities, from government attractive return risk profile, and argue that bonds to credits, from investment grade to high yield, Asian local currency bonds could continue to and from US to other developed and emerging deliver attractive returns for investors going markets. In this paper, we first review how these different sectors of the bond market have performed forward. historically, and argue that on a forward-looking Asian bonds have historically achieved basis, one of the most attractive opportunities may lie superior return and risk profile: Asian fixed in the Asian local currency bond market. income has outperformed other emerging Historical performance of Asian bonds market bonds, generating stronger returns with lower volatilities. This more efficient return The past few decades have been very good for fixed profile spans across all Asian fixed income income investors, propelled by interest rates falling to sectors, from rates, FX, and credits, and across historic lows. In Chart 1 we show how different sovereign, investment grade, and high yield equity and fixed income asset classes have performed over the past 15 years, a period bonds. encompassing the housing bubble, the Great Return opportunities: With strong macro Financial Crisis, the subsequent recovery, European fundamentals, compelling valuations, and a debt crisis, Taper Tantrum, China slowdown, Fed hike, favourable FX backdrop, Asian local currency the Covid-19 recession, and the historic rebound bonds have the potential to deliver returns from since: both carry and currency appreciation. We view Chart 1: Global fixed income asset class 15-year Asian local currency bonds as an attractive annualized returns and volatilities alternative to both high quality developed 8% Return US HY Euro HY market treasuries as well as a good complement 7% EM USD Sovereign to credits and other emerging market bonds. 6% EM USD Corp US IG 5% EM Local Bonds Why Schroders? A dedicated team with 4% UST Global Govt Euro IG Corp significant experience and track record 3% EM FX investing in Asian bonds, Schroders offers 2% investors an opportunity to take advantage of 1% T Bills Volatility this growing and attractive region in fixed 0% income. 0% 5% 10% 15% 20% Source: Schroders, Bloomberg, based on 15 year of monthly USD unhedged returns ending Dec 2020. See appendix A for the different market indices used in the analysis *Schroder International Selection Fund is referred to as SISF throughout this document. Schroders Onshore China Fixed Income January 2021 1 9% A few observations emerge from the returns and Return Asia USD HY 8% volatilities experienced over the past 15 years: Asia USD Sovereign US HY 7% Euro HY • USD assets have broadly outperformed US IG 6% Asia USD IG global, European, and emerging market fixed Asia Local Bonds 5% China Govt income assets 4% UST • As one would expect, the riskier segments of 3% Global Govt Euro IG Corp the market have delivered higher returns 2% Asia FX than the safer sectors, but also with higher 1% T Bills Volatility volatilities. High yield bonds performed the 0% best, followed by emerging market debt, then 0% 5% 10% 15% 20% investment grade debt, then governments, Source: Schroders, Bloomberg, based on 15 year of monthly then cash. USD unhedged returns ending Dec 2020. See appendix A for the different market indices used in the analysis • Within EM, local currency assets lagged, with Investors might be surprised to learn that historically EM local currency bonds not only EM Asian asset class performance has been this underperforming hard currency USD bonds, strong, even surpassing the US fixed income market but also exhibiting higher volatilities. returns. So what is happening here? And more The stronger relative performance of the US markets importantly, can investors expect this phenomenon versus global and EM has been well analysed so to continue? Below we take a closer look at Asian would not be a focus here. But investors might not local currency sovereign bonds and discuss some of be aware that if we took a closer look at just within the reasons that we believe will lead to continued the EM asset classes and compared the Asian market favourable risk return characteristics for Asian returns, we now could see an interesting pattern: sovereign bonds going forward. Chart 2: Asian and emerging market fixed income Asian economies have strong asset class 15-year returns and volatilities fundamentals 8% Return Asia USD Sovereign 7% Asia USD Credit EM USD Sovereign We believe the first reason for Asian bond markets to EM USD Corp 6% perform well is due to the stronger fundamentals of China Govt EM Local Asian economies relative to the global developed and 5% Asia Local Bonds Bonds other emerging market economies. Over the past 4% Global Govt couple of decades, emerging Asian economies have Asia FX 3% EM FX grown significantly faster than the rest of the world, 2% having overtaken the G7 countries in their share of 1% global GDP, and now contribute more than half of all Volatility 0% global GDP growth: 0% 2% 4% 6% 8% 10% 12% 14% Source: Schroders, Bloomberg, based on 15 year of monthly Chart 4: Share of global GDP between EM Asia and USD unhedged returns ending Dec 2020. See appendix A for G7 economies the different market indices used in the analysis 60 Emerging and Developing Asia It is very interesting that in every instance when we 50 Major advanced economies (G7) move from the broader emerging markets to just Asian emerging markets, the return profiles become 40 much more efficient, with improvements in both the 30 historical returns and a reduction in volatilities. Now, if we redraw Chart 1 showing only the Asian EM and 20 the global and US bond markets, we see that the 10 Asian EM fixed income sectors have been very competitive, delivering returns even in excess of US 0 1980 1985 1990 1995 2000 2005 2010 2015 2020F 2025F bond market returns: Source: IMF, as of October 2020 Chart 3: Asian and global fixed income market 15- year returns and volatilities Additionally, the growth differentials between Asian and other global economies have only widened over the past year. Due to cultural reasons and stronger government actions, Asian economies, led by China, are the first ones to enter the global pandemic and the first ones out. Chart 5 below shows the GDP Schroders Onshore China Fixed Income January 2021 2 trajectories of global economic regions from 2020- Source: Schroders, Bloomberg Economic Forecast based on 2022, indexed to 100 at the end of 2019. Asia ex- contributor composites, as at 19 January 2020. India 2020 and 2021 projections based on fiscal year 2021 and 2022 Japan is the only region with 2020 GDP exceeding 2019 level, and far outpacing other regions in If we look at Asian sovereign debt profile, we also developed markets or other emerging markets. notice a significant difference relative to other Europe and Latin America have been particularly emerging market countries. While total debt to GDP impacted by the pandemic with their GDP levels ratios have risen globally over the past year as expected to barely get back to 2019 levels only at the governments expanded fiscal spending to stimulate end of 2022. growth, chart 7 below shows how Asian economies’ external government debt to GDP levels have Chart 5: Annual forecasted real GDP levels of remained very low and stable, with many countries global economies (indexed to 100 in 2019) 115 near zero. 2020 2021 2022 110 Chart 7: External government debt to GDP of Asian and select emerging market countries (%) 105 25 2018 2019 2020F 2021F 2022F 100 20 95 15 90 10 5 0 Source: Schroders, Bloomberg Economic Forecast based on contributor composites, as at 19 January 2020 When we focus just on Asia ex-Japan as shown in Chart 6, we can see that China was the only major Source: Deutsche Bank Research, as at January 2021 world economy with a positive GDP growth in 2020, followed by expected continued sharp rebound in Compared to other EM countries that are more 2021. The rest of the Asian economies are benefiting reliant on external funding sources, Asian economies from this positive dynamic from China, as it is the are less vulnerable to the volatility of global capital largest trading partner in the region. Taiwan is the flows and can tap into the large domestic savings other economy that grew in 2020, thanks to its strong pools to manage their debt dynamics more semiconductor sector that benefited from the work- effectively. This more robust debt structure is one from-home technology boom as well as its reason that has helped Asian countries avoid defaults outstanding pandemic containment.
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