Head of Fixed Income -Asia Pacific, Aberdeen Asset Management Aberdeen recently sat down with Anthony Michael, Head of Fixed Income – Asia Pacific, to discuss Aberdeen’s views on the future opportunities and potential risks in Asia’s bond markets.

Economic developments in the West have created new global economic dynamics. Aberdeen Asset Management believes that investors should understand the potential effects these dynamics will have on investing in Asia. The end of U.S. quantitative easing and the increasing sovereign credit risk of developed nations have created a new dilemma for global asset allocators.

We believe that in the post-global financial crisis world, Asia’s bond markets are often regarded as a fringe market and a much misunderstood asset class by global investors. Because of this, Aberdeen believes that many investment opportunities in the region have been overlooked and, as a consequence, may offer unique opportunities for those looking to take advantage of solid fundamentals, desirable yield, and sustainable growth.

Key points

 

 

• Aberdeen believes that global investors remain under-invested to Asian bonds. Exposure is often made through global debt benchmarks; however, these benchmarks typically have low allocations to Asia, may not be particularly active, have allocations to less creditworthy countries and possess limited local currency exposure.

• Aberdeen believes that many investment opportunities in the Asian region have been overlooked and, as a consequence, may offer a unique opportunity for those looking to take advantage of solid fundamentals, desirable yield, and sustainable growth.

• Asia provides a diverse set of markets and a broad set of country issuers across the credit spectrum, offering what we believe are good opportunities for investors to enhance portfolio yields.

• The Asian fixed income asset class has shown relatively low correlation to developed-world bond markets, and Aberdeen expects this low level of correlation to remain for quite some time.

How does the U.S. downgrade impact your portfolios?

Any portfolio holding risk assets will be impacted by market weakness that results from the downgrade. That said, our portfolios have for a while been positioned defensively. In our Asian fixed income and multi-asset products, we have had a substantial USD underweight position for some time. Although, paradoxically, the downgrade may in the short term result in a flight to safety into the USD, we think the medium-term trend is for Asian currencies to strengthen further against key developed market currencies, driven by their stronger fundamentals.

What are the expected impacts to the Asian bonds market in the short to medium term?

The downgrade simply reinforces what we’ve been saying for a while, namely that the ratings agencies have not been properly reflecting developed market risk. Aside from the near term negative impact on sentiment, which will be supportive, paradoxically, of U.S. Treasuries and the U.S. dollar, longer term we expect capital to be reallocated away from developed market bonds and into Asian/EM bonds, providing longer term support for regional markets. Furthermore, the market is also reassessing the longer term global growth outlook. If the global growth outlook continues to deteriorate, this would also weigh on Asian growth prospects. While better domestic market growth drivers provide a buffer against some of these global headwinds, some downward revisions to regional growth forecasts should be expected. While the fundamental arguments for the continued appreciation of Asian currencies remains intact, one must be mindful of the strong correlation between Asian currencies and equity markets. If equity markets continue to come under pressure in the near term as a result of downward revisions to growth, Asian currencies may also experience some weakness. So near term some caution is warranted, but any weakness should present excellent buying opportunities in view of Asia’s stronger fundamentals and better growth potential.

Given the current market trends now taking place in developed nations, why should investors focus their attention on Asia?

Much has been said about the current debt levels of developed nations and the question remains as to whether these levels are sustainable. The U.S. downgrade serves as one example of the major fiscal dilemmas that the west is facing. The U.S. was recently forced to raise its debt ceiling and government debt in the U.S. and other countries, including Ireland, the G7 and Japan is projected to continue to rise over the next half decade. (See Chart 1 on the previous page for details on projected government debt levels in developed versus emerging countries.)

Aberdeen believes that the uncertainty surrounding the current and forecasted debt has turned investors’ focus to other markets with more fruitful opportunities. These opportunities include emerging markets and especially the Asian markets. We believe that, without a doubt, developing Asia is the place to be when considering the optimal risk-return profile.

Why have Asian economic fundamentals stayed attractive?

For Asia, the real crisis was in 1997—not 2008. Since then, companies and governments alike have focused on putting their balance sheets in order. In large measure, that focus helped them avoid the global financial crisis. At the same time, China and India have emerged as important drivers of growth. In India, household spending has increased despite inflationary pressures, underscoring the strength of its wage and employment dynamics.

China’s infrastructure investment, especially in its social housing program, shows no sign of slackening. Attractive fundamentals for Asia have resulted in significant capital flows into the region. The challenge for Asian economies from here will be to manage inflation and limit the formation of asset class bubbles.

Why do you feel Asian governments are better suited to withstand future global economic shocks?

Asian government debt levels are generally much lower than those of the West. In fact, the projected debt levels of many of the Asian governments are expected to fall over the next five years. When evaluating the stress levels of both developed and emerging market nations over the last 18 months, the gap between the two is quite pronounced. Especially from a fundamental perspective, emerging markets prove far healthier than developed nations and the difference has never been wider. This is illustrated in Chart 2 “Stress Index Emerging Markets and Developed Countries (RHS)” below.

Additionally, Asia’s share of global GDP is on the rise and as a group, developing Asia’s share is already ahead of both the U.S. and the EU. We think the current trend of world GDP shifting eastwards will continue for the medium to long term. As illustrated on the next page in Chart 3 “Composition of World GDP,” emerging markets are forecast to represent 77% of world GDP by 2050, with developing Asia forecasted to represent 49%.

How do Asian bonds fit into an overall fixed income portfolio?

Asia provides a diverse set of markets and a broad set of country issuers across the credit spectrum, offering good opportunities for investors to enhance portfolio yields. The credit ratings of 10-year Asian government bond yields range from AAA in Singapore to BB in Vietnam. The Asian bond market has also expanded to offer a diverse range of fixed income opportunities including inflation-linked bonds, investment-grade bonds, long-maturity bonds and new government issues. We believe that Asia, and specifically developing Asia, presents an expanding range of fixed income investment opportunities.

From a risk-return perspective, Asian bond markets have performed relatively well in comparison to U.S. high yield bonds, generating similar returns but with less volatility. The asset class has also shown relatively low correlation to developed- world bond markets, and we expect this low level of correlation to remain for quite some time.

What opportunities exist to invest in the Asian bond markets and what are their benefits?

We think the Asian bond market has two distinct markets—namely local currency and dollar bonds. The local currency bond market is the larger of the two and offers currency diversification, and hence the potential to benefit from regional currency appreciation. It also offers local interest rate exposure across markets of different credit quality. The Asian dollar bond market is smaller, largely investment- grade and offers an attractive yield over U.S. Treasuries.

Taken together, these two markets provide investors with a broad opportunity set in rates, currency and credit with the breadth and flexibility to meet a wide range of return expectations. Depending on which strategy is chosen, investors can potentially take advantage of an asset class delivering diversification and positive risk/reward benefits given low historical correlation with other asset classes. We also see Asia in particular as a compelling “lower risk” investment opportunity when compared to developed markets.

How do inflationary pressures in the region affect future trends?

When talking about inflation in Asia, you must also take into account the monetary policy of developed economies. In our view, developed country currencies present an interesting dilemma. Short-term slower growth forces investors towards safe havens such as U.S bonds, where yields are still near historic lows. But the consensus on current developments, particularly quantitative easing in the U.S., is that they could lead to detrimental levels of inflation. Of increasing concern is the West’s ability to service its debts, which undermine the credibility of its government bond markets. Asian governments on the other hand, are far healthier and more solvent than their Western counterparts, having much lower liabilities.

It now seems that Asia is looking towards domestic demand-led growth and this means the embracing of a stronger, appreciating currency. Furthermore, we believe Asian governments will be looking to invest at home and will allocate their savings to their growing capital markets and infrastructure projects, which will ultimately benefit their own populations.

Do you see continued support for Asian bond markets?

We believe the structural argument to be fairly compelling. With the region benefiting from strengthening economies, bond markets have matured, particularly in local currency issues. Indeed, the region’s sovereign and credit markets have been growing rapidly. At the same time, the investor base has grown and liquidity has improved. Given the greater depth and diversity of issuers across the credit spectrum and from a wide range of countries at different stages of development, we see significant opportunities for an active long term investment strategy.

Does this mean investors should make a discrete allocation to Asian fixed income?

In our opinion, yes, absolutely. We believe the Asian fixed income markets represent a unique asset class that justifies inclusion in a global portfolio. In our view, global investors remain under-invested in the region. Exposure is typically made through global debt benchmarks; however, these benchmarks typically have low allocations to Asia, may not be particularly active, have allocations to less creditworthy countries and possess limited local currency exposure.

Do you foresee that any developing Asian nations will receive upgraded investment status and if so, what would this mean for their capital markets?

Countries such as the Philippines and Indonesia, which boast growing economies and solid fundamentals, may be upgraded to investment-grade status. This will give pension funds the opportunity to invest in the region, greatly expanding the pipeline for asset allocation. In our view, this will happen in the next one or two years.

About Aberdeen Asset Management Inc.

Aberdeen Asset Management PLC, parent of Aberdeen Asset Management Inc., was founded in 1983 and has over $280 billion of assets for both institutions and private individuals as of June 30, 2011. We have 1,800 employees, located across 30 offices in 23 countries. Our firm is recognized for its global and emerging markets focus with investment professionals located in the regions and markets in which they specialize.

 

Important information

The above is for information purposes only and should not be considered as an offer, or solicitation, to deal in any of the investments mentioned herein. Aberdeen Asset Management does not warrant the accuracy, adequacy or completeness of the information and materials contained in this document and expressly disclaims liability for errors or omissions in such information and materials. Some of the information in this document may contain projections or other forward looking statements regarding future events or future financial performance of countries, markets or companies. These statements are only predictions and actual events or results may differ materially. The reader must make his / her assessment of the relevance, accuracy and adequacy of the information contained in this document and make such independent investigations, as he/she may consider necessary or appropriate for the purpose of such assessment. Any opinion or estimate contained in this document is made on a general basis and is not to be relied on by the reader as advice. Neither AAM nor any of its agents have given any consideration to nor have they made any investigation of the investment objectives, financial situation or particular need of the reader, any specific person or group of persons. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the reader, any person or group of persons acting on any information, opinion or estimate contained in this document. AAM reserves the right to make changes and corrections to its opinions expressed in this document at any time, without notice. Foreign securities are more volatile, harder to price and less liquid than U.S. securities. These risks are generally heightened for emerging market investments. Fixed income securities are subject to certain risks including, but not limited to interest rate, prepayment, extension and credit risks.

Investors should consider a fund’s investment objectives, risks, charges and expenses carefully before investing. A copy of the prospectus for Aberdeen Chile Fund, Inc. and Aberdeen Australia Equity Fund, Inc. that contains this and other information about the funds may be obtained by calling 866-839-5205. Please read the prospectus carefully before investing. Investing in funds involves risk, including possible loss of principal.

Closed-end funds, unlike open-end funds are not continuously offered. There is a one-time public offering, and once issued, shares of closed-end funds frequently trade at a discount from the net asset value. The price of the Company’s shares is determined by a number of factors, several of which are beyond the control of the Company. Therefore, the Company cannot predict whether its shares will trade at, below or above net asset value. Aberdeen Asset Management is the marketing name in the U.S. for the following affiliated, registered investment advisers: Aberdeen Asset Management Inc., Aberdeen Asset Management Investment Services Ltd., Aberdeen Asset Management Ltd. and Aberdeen Asset Management Asia Ltd. (collectively, the ‘Aberdeen Advisers’). Each of the Aberdeen Advisers is wholly owned by Aberdeen Asset Management PLC. “Aberdeen” is a U.S. registered service mark of Aberdeen Asset Management PLC.

 

About Aberdeen Closed-End Funds Aberdeen’s subsidiaries (the “Aberdeen Group”) have managed U.S. registered closed-end funds since December of 2000 and is the largest manager of emerging market closed-end funds offered around the world by both value and number.1 Aberdeen directly manages nine U.S. exchange-listed closed-end funds, one Canadian investment company and serves as investment subadvisor to two other closed-end funds managed by First Trust Advisors L.P. Many of Aberdeen’s closed-end funds available to North American investors include allocations to Asian bonds. Aberdeen’s complete closed-end fund range is:

• Aberdeen Asia-Pacific Income Fund, Inc. (NYSE Amex: FAX)

• Aberdeen Asia-Pacific Income Investment Company Limited (TSX: FAP)

• Aberdeen Australia Equity Fund, Inc. (NYSE Amex: IAF)

• Aberdeen Chile Fund, Inc. (NYSE Amex: CH)

• Aberdeen Emerging Markets Telecommunications and Infrastructure Fund, Inc. (NYSE Amex: ETF)

• Aberdeen Global Income Fund, Inc. (NYSE Amex: FCO)

• Aberdeen Indonesia Fund, Inc. (NYSE Amex: IF)

• Aberdeen Israel Fund, Inc. (NYSE Amex: ISL)

• Aberdeen Latin America Equity Fund, Inc. (NYSE Amex: LAQ)

• First Trust/ Aberdeen Global Opportunity Income Fund, Inc. (NYSE Amex: FAM)

• First Trust/Aberdeen Emerging Opportunity Fund, Inc. (NYSE Amex: FEO)

• The Singapore Fund, Inc. (NYSE: SGF)

 

 

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