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Why Asian Bonds Aren't Just Short-Term Bets

Dhara Ranasinghe|Senior Writer, Asia Pacific

Asian government bonds have been seen as somewhat of a safe-haven this year, benefiting from volatile global markets. But some experts argue that the appeal of certain regional bond markets as a longer-term investment is growing, suggesting that investors won’t rush back into the world’s bigger debt markets in a hurry when risk appetite returns.

According to EPFR, a provider of fund flows data, foreign Inflows in to emerging market bonds have amounted to about $13 billion so far this year, compared to $3 billion in 2011 and $5.5 billion in 2010. And while benchmark U.S. government bonds have seen outflows for two straight months running, regional currency bonds have seen positive inflows for the past four weeks in a row.

Andre de Silva, the Head of Asia-Pacific Rates at HSBC, says a combination of factors is behind the strong demand for Asian debt.

“Even if we’re in a coordinated global slowdown and even if there’s been heightened risk aversion, it’s not been as distinct as we’ve seen before,” de Silva said.

“Namely in Asia, there’s been reinvestment (in bonds) and there hasn’t been a flight back home – particularly back to the U.S. Why? Yields are very low, in some cases negative and at the same time, there is a pumping of liquidity by major central banks and that’s going to continue,” he added.

Anthony J. Michael, Head of Fixed Income at Aberdeen Asset Management Asia agrees, adding that since the onset of the global financial crisis, investors have been viewing government bonds in the region increasingly as a long-term investment.

“At the start of the financial crisis, we went through phases of ‘risk off’ and money went back out of the region, but 4-5 years of financial crisis means that we see people taking a long-term view on Asian bonds and the long-term macro view of the region has helped,” said Michael.

“We’ve got quantitative easing in the U.S. and Japan, so there has been a strategic allocation shift into Asia,” he added.

According to de Silva, even though yields on Asian bonds have come down they remain appealing relative to their counterparts in bigger debt markets because they offer real yields, or a return that is adjusted for the effects of inflation.

South Korea’s benchmark 2-year bond offers a yield of 2.86 percent, while 2-year bond yields in the Philippines are at 2.95 percent versus 0.27 percent in the U.S. and 0.09 percent in Japan.

South Korea Shines

De Silva said South Korea is one of the more pronounced examples of foreign investors showing interest in staying in the bond market over the long-term, as indicated by growing foreign demand for bonds of a longer duration.

“Foreign ownership is close to historic highs in Korean paper, that’s mostly in 2-5 year paper and is moving up (the yield curve),” he said.

Foreign investors increased their holdings of South Korean domestic bonds by a net 1.1 trillion won ($974.6 million) in the first 20 days of July and sold a net 0.6 trillion won ($31.6 million) of local stocks, according to the latest official data from South Korea.

The bond market has seen a steady inflow of foreign funds in recent months because interest rates in South Korea, at 3.00 percent, are above those in other developed countries.

Aside from South Korea, De Silva also likes Philippine debt given the country’s falling budget deficit, real yields and less volatile currency markets.

But a swelling current-account deficit in Indonesia has made local bonds less appealing, he added.

Michael said Aberdeen Asset Management was a long-term investor in the bond markets of Malaysia, the Philippines, Indonesia and South Korea.

“Interest in fixed income in places such as Malaysia is going up,” he said.

Treasurys Still Attractive

Emerging market bonds have gained ground as an alternative safe-haven this year as weak economic growth in the United States and Europe and the relatively robust finances in Asia prompted investors to look to east.

Still, despite recent outflows from Treasurys, some analysts said they continued to recommend buying benchmark U.S. debt to investors.

“A lot of people thought the U.S. Treasury market was dead and buried, but it’s not,” said Hans Goetti, Chief Investment Officer at Finaport.

“We think the deleveraging cycle will last another 3 to 5 years, this is highly deflationary so the Fed will probably try to get the 30 –year bond yield down to about 2 percent, so the 10-year yield will also come down from here, so we’re still recommending U.S. Treasurys,” he said.

Yields on 30-year U.S. bonds stood at 2.75 percent on Tuesday, while 10-year yields were at 1.66 percent.

- By CNBC's Dhara Ranasinghe