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Exploiting inefficiencies

Columbia Threadneedle Investments' fund manager Clifford Lau is holding defensive Asia bonds while being selective on Asian high-yield plays

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Clifford Lau, Head of Fixed Income, Asia Columbia Threadneedle Investments: 'The fundamental story of Asia remains very solid. Foreign exchange reserves continue to pick up. A few big infrastructure projects, like the One Belt One Road project will bring positive hopes for the region to deliver above-average GDP returns.'

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Ultimately, with Asian markets still inefficient, Mr Lau says that flexible, diversified bond funds can still exploit valuation differences to generate superior returns across the cycle. PHOTO: FREEIMAGES

THESE are buoyant times for Asia fixed income investors.

With inflation expected by many central banks to stay low amid mostly lukewarm economic growth, fixed income investors have rushed into all kinds of riskier assets.

"The game now for fixed income investors is to overweight spread risk, and to stay invested in Asian high-yielders and perpetual securities although on a very selective basis," says Clifford Lau, Columbia Threadneedle Investments' head of fixed income for Asia.

While Mr Lau is similarly optimistic on the market outlook, he is more selective about the risks he takes on.

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His top-quartile performing Threadneedle (Lux) Flexible Asian Bond Fund is, for instance, only 15 per cent invested in high-yield bonds as at end-June.

While he invests in perpetual bonds, he chooses fundamentally strong issues in sectors like healthcare and consumer, with coupon step-up features.

The bulk of his portfolio is in investment-grade Asian bonds, which he prefers versus pricier sovereign bonds.

The track record for such bonds is good and their fundamentals are strong, he says.

"Asia US-dollar investment-grade corporate bonds offer the best risk-adjusted returns against any other bond asset class, with 8 per cent annualised returns and 4 per cent volatility from end-2008 to April 2017. This is much better than US investment-grade corporate bonds or emerging markets local currency bonds," Mr Lau says.

The low volatility of Asian investment-grade corporates is due to global investors getting more comfortable with Asian bonds, he says.

"Asian bonds are becoming a respectable, standalone asset class."

Strong fundamentals

Another reason to be bullish on the bonds issued by blue chip corporates is their strong credit fundamentals. This is seen in stabilising net income margins and interest expense coverage ratios, higher cash to total debt ratios, and lower debt-to-earnings ratios.

Cash as a proportion of total debt, for example, is up from a low of 25 per cent in 2013 to 33 per cent in 2016.

The annual Ebitda (earnings before interest, taxes, depreciation and amortisation) of Asian investment-grade companies can cover their annual interest expenses by more than nine times - a "strong number".

The equivalent ratio for high-yield corporate bonds has declined from 5.4 times in 2010 to 2.4 times in 2016. In the same period, net debt for Asian high yield has doubled to above four times Ebitda, though the ratio improved slightly from 4.4 times in 2015 to 4.2 times in 2016.

This is not cause for concern yet, Mr Lau says. He points out that liquidity remains adequate, with cash as a proportion of total debt for Asian high-yield corporates rising from 25 per cent in 2014 to 30 per cent in 2016.

Infrastructure boost, political stability

Moreover, if the fundamental backdrop is strong, companies will be able to afford higher debt to Ebitda ratios, he says.

"The fundamental story of Asia remains very solid. Foreign exchange reserves continue to pick up. A few big infrastructure projects, like the One Belt One Road project spearheaded by China, will bring positive hopes for the region to deliver above-average gross domestic product (GDP) returns," Mr Lau says.

Asia is still expected to grow by 6-7 per cent a year. China economic numbers recently surprised on the upside, while India is successfully keeping inflation under control. At the same time, commodity markets have recovered, improving corporate earnings.

There is also political stability in Asia, improving its outlook, Mr Lau says.

Apart from a potential general election by next year in Pakistan and Malaysia, there are no major political events happening in the near term.

While China's Congress will meet later this year and usher a leadership transition, the political backdrop should be stable, he says.

"By contrast, you get political drama in the US every day."

Managing liquidity risks

What is of concern to Mr Lau is how the market for certain high-yield issues is still very thin.

"Deal sizes are not big at US$200 to US$250 million. The market has quite a lot of high-yield bonds which banks are selectively trading or making markets in," he says.

The best way to handle liquidity concerns is to be very confident about the bonds one is buying, and to possess holding power through market volatility. "You have to be careful about what you decide to put in your book. We ensure we hold companies with a solid credit profile which will honour their coupon and principal payments," he says.

Meanwhile, Mr Lau is keeping 90 per cent of his bond holdings in liquid issues as at end-June.

"The most important decision I make for my portfolio is to stay liquid as much as possible," he says.

Ultimately, with Asian markets still inefficient, Mr Lau says that flexible, diversified bond funds can still exploit valuation differences to generate superior returns across the cycle. "We always have to reinvent ourselves and be dynamic in our asset allocation, across the US-dollar, local currency and foreign exchange markets," he says.

"Investors should still continue to closely monitor when and how global interest rate normalisation would happen. But this is unlikely to be an event risk this year."

The material in this publication is for information only and does not constitute an offer or solicitation of an order to buy or sell any securities or other financial instruments to anyone in any jurisdiction in which such offer is not authorised, or to provide investment advice or services.

 

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