Asia Fixed Income Needs a Bigger Map

Kelvin Pang (0:00)

Welcome to Thoughts on the Market. I'm Kelvin Pang, head of Asia Credit Strategy in Morgan Stanley. Today, why the challenge in Asia may not be the region at all, but the way investors have traditionally looked at it. It's Tuesday, October 13, at 8am in Hong Kong.

Picture this, you're shopping in a supermarket. As you walk down the aisle, you notice half of them are off limits.

It's unexpected. Something similar has happened in Asia fixed income. The region's fundamental remains supportive, but the traditional investment universe have become increasingly constrained. The pressure began in early 2023, when US policy rates rose above those in much of Asia for the first time since before the global financial crisis.

The environment that has supported Asian bond market for years turned upside down. Consider Asia Dollar Credit. Issuers have increasingly turned to cheaper local currency financing, which is shrinking dollar bond supply. Asia Dollar Credit is now on track for a fifth trade year of negative net supply. At the same time, investment grid spread had tightened to 55 basis point. That makes Asia Investment Grid credit the most tightly valued major credit market globally. And investors have taken notice of this. Assets in dedicated Asia Credit and HYU funds have fallen 62% from their 2021 peak, from roughly $75 billion to around $29 billion.

But we feel Asia itself is not the problem. In fact, Asia Pacific nominal GDP growth could rise from $41 trillion US dollars in 2025 to $54 trillion by 2031 That would account roughly one-third of global nominal GDP growth over that period. And most importantly, investment is also accelerating. Asia capital spending could rise from $11 trillion to $16 trillion by 2030 That would mark the strongest industrial cycle since the mid-2000s. And we think this extends well beyond AI, with energy, defense and broader industrial investment all playing major roles. The key issue here is how investors have traditionally looked at Asia. They basically need a bigger map. That broader map is what we call APAC fixed income. Traditional Asia fixed income has largely focused on US dollar credit and local currency government bond across emerging Asia.

APAC fixed income adds convertible bonds and local currency corporate credit. It also brings Japan and Australia into the mix.

So what's the advantage of this broader map? You see, each of these pieces behave differently. Convertible bonds let investors participate in regional growth through their equity link. APAC dollar credit plays a more defensive role with a mostly investment-grade US dollar denominated profile. Local currency rates provide exposure to interest rates, currencies and the economic cycle. At the same time, local currency corporate credit broadens credit and sector exposure. Together, they create a more flexible mix of risks across challenging economic conditions. For example, when growth and inflation rise together, convertible bonds can benefit from their equity link. In a recession, currency hedge local bonds can benefit from falling rates while limiting foreign exchange risks. During stagflation, dollar credit can offer more defensive characteristics. Our portfolio analysis since 2023 suggests a diversified APAC fixed-income portfolio could target a 7.5% return with a vol of roughly 4%, depending on allocation constraint. Investors increasingly need to manage currency exposure as the dollar cycle shifts.

For years, investors could navigate Asia bonds with a relatively narrow toolkit. Today's market demands more flexibility. The opportunity in Asia has not disappeared. The better question may be whether investors are looking at enough of it.

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