Update on Exotic Fixed-Income
A while ago I commented on the expanding opportunities in Emerging Markets Corporate Credits as our domestic fixed income market looked increasingly less attractive; this exotic fixed income update wants to highlight the specific Asian segment as a potentially attractive idea.
The Asian bond market can be attractive in terms of Sovereign issues and Corporates as well; the credit quality of many Asian Sovereigns has improved dramatically over the years and it is backed by large current account surpluses. Especially when compared to the Euro Sovereigns and the highly expensive US Treasuries, Asian Sovereigns seem to deserve attention. This is not to say that they are risk free as this concept is becoming increasingly disconnected from the old fashion definition of government issued securities anywhere in the world. Teresa Kong of Matthews Asia reports significant increases in liquidity, transparency and diversification in the Sian bond market.
An exposure to international bonds carries an additional element to the investment; the position will be affected not only by the general level of interest rates, credit changes and liquidity but also currency exposure. Exposure to different currencies is a new element of smart diversification that at least large portfolios should consider. Teresa Kong of Matthews Asia makes a good point when she states: “If one were to think of investments as a way to generate income to cover expenses over the long term, having a proportion of income denominated in the same currency as future expenses might act as a currency hedge. Given that Asia accounts for an increasingly larger portion of U.S. imports, having an income stream derived from underlying instruments denominated in Asian currencies might be prudent.”
The higher yield and the diversification effect do come with a price: a higher level of volatility when compared to US bonds. However, Asian fixed income carries half the volatility of US equities and roughly one third of the volatility of Asia Ex-Japan equities (source: Matthews Asia).