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Asian Sovereign Bonds Becoming Alternative Safe Bets?

As the sputtering U.S. and European economies continue to grab headlines, and investors shun equities because of their volatility, Asian sovereign bonds have been quietly gaining favor as an alternative safe haven.

Mark Harwood | Stone | Getty Images

Investors have continued to put money into Asian sovereign bonds this year as weak data from developed economies and the prospect of a Greek exit from the euro zone sparked a stampede from risk assets such as commodities, stocks, and foreign exchange. According to data from U.S. research company EPFR Global, funds focused on Asian emerging-market bonds attracted $14.4 billion in the first quarter of this year, compared with $1.9 billion in the year-earlier period.

“We have been below consensus with respect to the growth outlooks of both the U.S. and China and as the data deteriorates and the market adjusts its expectations, this is likely to support bond market performance over the third quarter at least,” Kenneth Akintewe, Portfolio Manager with Aberdeen Asset Management, told CNBC.

The average yield for example on a representative local currency benchmark like the HSBC Asian Local Currency Bond Index is almost 4-5 percent on average, which, in comparison to yields in developed markets that are facing fiscal crises, is reasonably attractive, Akintewe said. And these yields will continue to be a draw because of the strong financial positions of most governments in the region, he added.

Indonesia, for example, has public debt of less than a quarter of GDP, and a much lower reliance on European exports. Yet, its 10-year rupiah bonds yield about 6.05 percent compared to 1.45 percent on equivalent U.S. Treasurys.

The Philippines is also a surprise refuge. The government has amassed $76 billion of foreign reserves, or about six times its short-term external debt, according to the latest data available from the central bank. About 95 percent of its debt holders are still domestic investors, who buy the Philippine peso bonds that pay about 4 percent more than U.S. Treasurys.

Ratings agency Standard & Poor’s also raised the country’s credit rating this month, taking it one step away from an investment-grade economy.

Nicholas Ferres, Director of Asset Allocation at EastSpring Investments, likes South Korean and Vietnamese sovereign bonds, and calls the latter “one of the more interesting bonds within Asia and the emerging markets”. Vietnamese 10-year bonds are yielding 10 percent.

“The yield (carry) is attractive, the currency has depreciated about 32 percent over the past few years and inflation appears to be moderating from a high level,” Ferres said. “Vietnam has suffered from excessive credit growth and high inflation over the past few years which has put pressure on the external position and the currency. But the fundamentals should improve looking forward.”

Aberdeen favors local currency bonds in Malaysia, Thailand, Philippines and South Korea.

Asian bonds are also attractive for their relatively lower default rates versus global average. According to Moody's, the default rate for Asian bonds - including corporate issues - over the last 10 years is only 0.8 per cent versus 1.8 per cent for the global average. In fact, no Asian investment grade bond has defaulted since 1999.

In Asia, the only sovereign bonds with AAA ratings are those issued by Singapore, Hong Kong and Australia. The next most highly-rated ones are New Zealand, Chinese, Taiwanese and Japanese paper, followed by South Korean, Malaysian and Thai bonds.

But ratings are just one way to assess risk, Aberdeen’s Akintewe said. Investors will have to look at more than the individual sovereign issuers and analyze the merits of their investments.

Ferres of EastSpring agrees, and adds ratings are not really relevant in his assessment of the investments, but only if the yield, and hence, premium for credit risk, provides enough compensation.

“Markets will price deteriorating or improving fundamentals ahead of the agencies,” he said. “The question is whether the improvement or deterioration is already priced in the local yields and/or currencies.”

- By CNBC's Jean Chua.

Contact Asia Economy

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