Is it time to add Asian investment grade bonds to your portfolio?

The picture on the bond market has changed significantly since the beginning of the year – from a possible “Fed pivot” and an expected series of interest rate cuts to “higher rates for longer.” So now, the markets’ forecast of the Fed cutting rates by 150 basis points (bps) over the year has fallen to just 47 bps, driven by months of higher-than-expected inflation and a robust US economy.

Eastspring Investments believes that the US economy and inflation will eventually weaken to the point where the Fed will have to cut rates. However, the timing and extent of these cuts have become less predictable. Despite this uncertainty, Eastspring sees a compelling opportunity in bonds, particularly Asian investment grade (IG) bonds.

“Asian bond yields are at multi-year highs, presenting investors with an attractive and steady source of income, and an opportunity to guard against future potential declines in short term money market rates which may come earlier than expected if the Fed pivots sooner,” wrote Rong Ren Goh, Portfolio Manager at Eastspring Investments in a market insight.

According to Goh, the benefits of elevated bond yields are often under-appreciated. He notes that investors can achieve meaningful yields without taking on significantly higher credit risk. A scenario where inflation reaccelerates would necessitate a significant rise in rates, leading to capital losses for bonds, but this is not Eastspring’s current base case. Goh also suggests that if the US economy faces a hard landing, bonds are expected to outperform equities, with Treasuries and investment-grade bonds showing more resilience than high yield bonds. “Thus, investment grade bonds can provide investors with much-needed portfolio diversification,” Goh added.

Diverse opportunities for investors in Asian investment grade bonds

Eastspring points out that about 85% of the JP Morgan Asia Credit (JACI) Index is rated Investment Grade. “Most of the region’s sovereign bonds have an IG rating and are expected to retain that credit rating over the medium term,” said Goh.

As an extension to the Asia Credit Index, which is Asia ex-Japan, JP Morgan launched the JACI Asia Pacific last year. By including Japan, Australia, New Zealand, and other Pacific countries, it “expands the universe dramatically,” opined Omar Slim, Co-Head of Asia Fixed Income at PineBridge Investments.

Australia and Japan together make up 35.4% of the index, while China makes up only 23.4%—compared to 36.9% in JACI. Also, the JACI Asia Pacific remains very high quality, consisting of 88.6% investment grade bonds.

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“For investors only invested in global investment grade bonds now, adding Asia Pacific IG to the portfolio helps add exposure to emerging markets – but with the relative safety provided by the presence of several developed countries,” Slim opined. “Aside from Japan and Australia, these include markets classified as advanced economies by the International Monetary Fund, such as Hong Kong, South Korea, New Zealand, and Singapore.”

“The attractive technicals of APAC IG (with low issuance meeting growing investor demand), generally steady fundamentals, lower duration, and lower credit-spread volatility all combine to make the asset class an attractive one. When added to an overall Global IG portfolio, they also result in a boost in returns and lower volatility,” Slim concluded.