Asia Total Return Bond Strategy: Celebrating ten years of compelling returns
Manulife Investment Management’s flagship Asia Total Return Bond strategy (“the Strategy”) recently marked its 10th year anniversary. The Strategy adopts a flexible and dynamic approach to the rapidly-growing asset class, allocating across a wide range of currencies and credits in the Asia Pacific (ex-Japan) region. Since its inception in September 2009, the Strategy’s unique approach has created value for investors through a diverse range of market environments.
As we commemorate the Strategy’s 10th anniversary, we recap its achievements and innovations over the past decade. We also examine how the Asian fixed income universe has evolved into a highly diversified, high quality and independent asset class, setting the stage for investors to potentially achieve even greater outcomes for the next 10 years and beyond.
The Strategy’s performance over the past 10 years
The Strategy’s nimble investment approach has delivered consistently attractive risk-adjusted returns: cumulative gross returns over 10 years1 stand at 65.4%, equivalent to a 5.16% p.a. annualised return and a risk-adjusted return of 1.00% p.a. since inception (see Chart 1)2. Assets under management of the Strategy have grown over twenty-fold in the same time period, from US$20 million to US$463 million as of September 2019, while the portfolio management team manages over US$12 billion of Pan-Asian fixed income assets across multiple mandates today.
We break down the Strategy’s return into three key sources: interest rates, credit, and currency. Each source has positively contributed to returns since inception. As shown in Chart 2, the portfolio’s total duration has ranged from 2.5 years to 5.3 years, exemplifying the Strategy’s dynamic approach to capturing interest rate opportunities across different cycles.
In addition, the Strategy pursued a flexible investment approach over the years reflecting the diverse opportunity set in the Asian bond universe. Meanwhile, our active blended approach can be demonstrated by the historical changes in exposure between US dollar and Asian currencies.
Below is our performance contribution over the past 10 years:
Interest rates
Over the past decade, interest rates were the largest contributor (45%) to cumulative returns amidst accommodative monetary policy from global central banks as well as active positioning across local Asia bond markets. In particular, our on-the-ground local fixed income team in Jakarta helped position us for a strong downward trend in interest rates in Indonesia3 when the portfolio was overweight duration, notably boosting performance. The portfolio’s US dollar duration active management also positively contributed to returns, although to a lesser extent.
Credit
Active credit management was the second largest contributor (39%) to the Strategy’s cumulative return since inception. Credit selection is imperative in the large and diverse Asian fixed income universe, where the selection of bonds is a main source of return.
The Strategy’s credit profile has evolved along with structural changes in the asset class. Overall, the Strategy has maintained an average weighting of 15% in the high-yield segment to allow investors to partake in the compelling upside of this market, while actively managing portfolio risk by maintaining an average investment-grade rating for the portfolio4. Over time, we strategically increased exposure to the “BBB”-rated corporate space5, as more quality Asian corporates issued bonds; the yield-to-quality was a sweet spot in this credit segment. Finally, security selection has always remained a top priority, with the Strategy recording zero credit default since its inception6. This is a reflection of the strong collaboration between the Strategy’s portfolio managers and the Asian credit research team.
Currency
Finally, currency positioning added a smaller but steady contribution (16%) to the Strategy’s return. Our blended6 Strategy can establish both US dollar and Asian currency exposures through investments in Asian bonds denominated in US dollar and local currencies. The Strategy’s exposure to key Asian currencies such as the Indonesia rupiah and Chinese renminbi during periods of US dollar weakness, helped contribute to positive currency returns.
The Strategy’s competitive edge
The Strategy’s compelling performance over the past decade can be att ributed to several key factors: the fl exible approach of the Strategy, a stable portfolio management team with a unique regional footprint, and our dedication to innovation.
Flexibility of the Strategy
Manulife Investment Management’s Asia Total Return Bond Strategy adopts a “go anywhere” approach that dynamically seeks opportunities in both hard currency and local currency bond markets across the region with the objective to maximising return potential. In other words, it invests fl exibly from across the entire US$18 trillion Asian fixed income spectrum8. This “blended” Strategy diff ers from other more rigid strategies that exclusively focus on either US dollar denominated or local currency credits in the region. Thus, our Strategy can be more diversifi ed than pure US dollar Asian bond portfolios, while also less volatile than pure local currency strategies.
Strength of the Pan-Asian Fixed Income team
The Strategy is managed by our Pan-Asian Fixed Income team, supported by more than 50 investment professionals located in 10 offi ces across Asia. Besides the notable size, two other factors set the team apart:
Team stability and continuity
Endre Pedersen, Asia Fixed Income Chief Investment Offi cer, and Portfolio Manager Neal Capecci have been managing the Strategy since its inception 10 years ago. Seasoned portfolio managers Jimond Wong and Murray Collis subsequently came on board. The Strategy’s management team has worked closely for a signifi cant period of time, creating a team with complementary strengths, bringing synergy and stability to the table. This is a key factor that distinguishes our Strategy from industry peers.
Unique regional footprint
The Pan-Asian Fixed Income team has analysts located across the region, including important emerging markets (EM) such as Indonesia and China. Our unique regional footprint serves as a key competitive advantage, as we are able to gather proprietary intelligence and trading ideas on-the-ground across Asia.
Strategy Innovation: Incorporating Environmental, Social and Governance (ESG)
To augment our competitive edge, Manulife Investment Management’s Pan-Asian Fixed Income team continually seeks to adopt innovative policies. In 2015, our fi rm became a signatory to the UN Principles for Responsible Investment (PRI) and since then, we have formally incorporated a robust ESG perspective into our investment analysis and decision-making processes.
Apart from the traditional research and fi nancial analysis on every single issuer, our credit analysts work closely with our dedicated ESG research team to review ESG factors. In addition, a dedicated ESG taskforce for our Asian Fixed Income portfolios has been set up to track the progress of our ESG integration.
Through our proprietary ESG framework, we examine the level of ESG risks which the issuers are exposed to, and then accord an appropriate risk intensity ranking to each of the E, S, and G factors. The rankings focus on risks that may impact the credit profi le of a company, which may take the form of reduced cash fl ow, weakened protection of creditors’ interests, or other credit considerations that may infl uence default risk.
Each intensity ranking corresponds to an estimated impact (in notches) to our proprietary internal risk rating. This forms the basis of our internal credit rating as we assess the relative merits of issuers, the fair value of their bonds, and whether the bonds are investable.
Palm oil production in Asia is an example where ESG factors impacted our credit assessment. The industry’s associated environmental and social eff ects, including deforestation, water usage, loss of biodiversity, destruction of the underlying peatland and poor labour safety could result in credit risks to companies in the sector. These negative eff ects, which hamper market access and operations, raise questions on sustainability and the ability of plantations to maintain the relevant sustainability certifi cations.
Why Asian fixed income now?
The Asian fixed income universe has experienced significant transformation over the past decade. Indeed, investors have traditionally viewed the market as part of a broader asset allocation to EM fixed income. However, over time, Asia has distinguished itself as a quality, stand-alone market worthy of its own strategic asset allocation.
We believe several compelling reasons underpin this palpable shift in investors’ perception:
Asia offers strong economic fundamentals, attractive real yields and an improved credit profile
Asia’s increased influence in global fixed income markets is primarily due to the region’s dynamic economic performance, attractive real yields and improved credit profile. Asia is one of the most diverse regions in the world, accounting for 60% of the world’s GDP growth rate and is home to 40% of the world’s population9.
The robust rate of regional economic growth, coupled with the diversity of economic growth sources, has translated to an improved credit profile for Asia over time and differentiated itself from other EMs. Almost all major Asian markets boast investment-grade sovereign ratings (except for Vietnam), and are generally higher rated compared with other EM regions10. In contrast, other large EM countries such as Argentina, Brazil, Russia, Turkey, and South Africa have seen significant credit rating downgrades over the past decade11.
At the same time, prudent macroeconomic management of inflation by Asian central banks has helped the region become home to attractive real yields for sovereign debt (see Chart 4). This is in contrast to the increasing sea of negativeyielding debt in developed fixed income markets, which stands at more than US$15 trillion12. Overall, Asian bonds stand out as a compelling solution for forward-thinking global investors seeking sustainable returns, higher real yields and potential diversification benefits.
The rise of China in global fixed income markets
The emergence of China‘s onshore bond market is one of the key regional developments over the past 10 years. While it is the world’s second largest economy (measured in nominal GDP), China is currently home to only the third-largest, but rapidly growing, bond market; it grew at an annualised rate of 16.6% p.a. over the past five years-doubling in size13.
Despite its rapid growth, the bond market is still relatively closed with a low level of foreign ownership, at less than 3% of the onshore bond market14. Nevertheless, this is changing as investors globally show increasing interest in the market’s diversification opportunities and its inclusion in major global bond indices. Indeed, we estimate that recent announcements by Bloomberg Barclays and JP Morgan to include Chinese bonds in global bond indices could result in up to US$600 billion of passive money flowing into the Chinese onshore bond market15.
With this increased significance, Manulife Investment Management is uniquely positioned to help investors tap opportunities in the rapidly expanding China market. We have been investing in China bonds (both onshore local currency and offshore US dollar-denominated) since the inception of our Strategy in September 2009. Our portfolio managers have also been actively investing in Chinese local bonds via the offshore “dim sum” bond market, as well as onshore through the China Bond Connect avenue.
Structural changes in Asia’s fixed income investment universe
Finally, we believe that investors will benefit from structural changes in the Asian fixed income universe over the medium term. Over the past 10 years, the Asian fixed income universe has both deepened and widened. The number and types of issuers have increased, boosting the market’s overall liquidity and providing compelling new investment opportunities.
Using the J.P Morgan Asian Credit Index, which comprises US dollar denominated Asian bonds (100%) and whole universe recently surpassed the US$1 trillion mark as an example15, the Index’s composition by sector has evolved significantly since 2009. By broad sector, sovereign and quasi-sovereign issuers accounted for close to half of US dollar credit issuance in 2009; financials and real estate now account for around 40% of the index (see Chart 5).
By sovereign issuers, Korea represented 28% of the market capitalisation, followed by Hong Kong (15%) and the Philippines (13.5%) back in 2009; this profile evolved significantly in just 10 years, with China now representing 51% (6.4% in 2009) of the total market capitalisation, followed by Indonesia (11.1%) and Korea (8.8%). This new norm would demand our China credit team’s expertise and scale to navigate risks via thorough screening of the issuers.
Finally, the quality of credits has improved: In 2009, 30.8% of the credits were below investment grade. In 2019, the level has decreased to 23.3%. The decrease in the proportion of high-yield credit issues reflects numerous factors, including the sovereign credit upgrade of key regional markets (such as Indonesia, the Philippines) to investment grade in this time period.
Furthermore, the “BBB” rated credit segment has grown and deepened; its weight increasing from 12.7% to 39.3%, whilst the number of bonds has also increased from 60 to 564. We are particularly interested in the corporate “BBB/A” space in Asia, which offers an attractive risk-reward profile compared to global bond offerings.
On the demand side, the regional investor base for Asian credit has also evolved. Over the years, we have observed a growing investor base from Asia and a reduced pool of investors from the US and Europe. This is reflected by the new issue allocation by region (80% of US dollar bonds issued in Asia vs 44% in 200917). The strengthened regional investor base offers more stability for the asset class, particularly in times of increased volatility and potential risk of capital flight.
Conclusion
Overall, the Strategy’s evolution along with the Asian fixed income universe underscores several key trends that are likely to continue over the next 10 years and beyond.
Improving market quality:
The overall quality of Asia’s fixed income market is high and it continues to strengthen. This is evident from the improving sovereign credit ratings and changing index composition, as markets transition from primarily high-yield issuers to investment-grade ones such as the Philippines and Indonesia.
Increasing diversification opportunities:
We expect the Asian fixed income universe to continue expanding over time. Younger economies such as Vietnam will continue to diversify its financing from traditional bank loans to capital markets, while new industries - such as social media and mobile taxi network providers which did not exist 10 years ago – come into play. In addition to new industries, we expect tremendous fixed income opportunities in relatively new markets such as India where we are establishing a local presence.
Opening of China’s bond market:
China is opening its onshore bond market to foreign investors and attracting more companies to issue in renminbi onshore. This process will continue over the next decade, making it one of the most important fixed income markets globally.
The Asia Total Return Bond Strategy has offered investors 10 years of compelling returns. The flexible, nimble and dynamic nature of the Strategy has navigated markets of diverse conditions over the past decade. Our proven track record, together with our unique footprint, adds strength to the Strategy. As we look forward, we believe the Strategy will continue to perform strongly on the back of positive developments in the Asian fixed income market, rewarding investors who are looking for long-term alpha generation.
1 Time period of performance examined was September 2009 to September 2019. Performance shown in US dollar, gross of fees and does not include advisory fees and other expenses an investor may incur, which when deducted will reduce returns. For periods more than 1 year, return figures be annualised. Past performance is not indicative of future results. Changes in exchange rates may have an adverse effect. 2 The risk-adjusted return is calculated as the annualised return of the Strategy divided by its standard deviation, in US dollar. Source: Manulife Investment Management, as of September 2019. The Strategy's benchmark is a blended one reflecting the Strategy: 50% of the benchmark is composed of the J.P. Morgan Asia Credit Index (USD); the other 50% is composed of the JP Morgan Emerging Local Market Plus Asia Index. Performance shown is the Asia Total Return Bond composite gross of fees. Past performance is not a guarantee of future results Composite gross return calculates the average value of the performance of all the investment Manulife Investment Management Limited, Manulife Investment Management (US), Manulife Investment Management (Europe) Limited, and Manulife Investment Management (Hong Kong) Limited claim compliance with the Global Investment Performance Standards {GIPS®). To receive a complete list and description of Manulife Investment Management's composites and/or a presentation that adheres to the GIPS standards, contact Institutional Sales at 1-888-332-7132, or visit us atwww.manulifeam.com. 3 In 2016, Bank Indonesia surprised markets with its aggressive monetary policy easing – it cut the key interest rate six times to boost its economy amid muted inflation. 4 The Strategy has maintained a 40% limit on high-yield debt since inception, with a 25% limit on corporate high-yield debt holdings. 5 “BBB” refers to the Standard and Poor’s rating of investment-grade bonds. The Strategy increased exposure to this credit segment from 10% in September 2009 to roughly 44% as of August 2019. 6 Source: Manulife Investment Management. 7 “Blended” in this context refers to the ability to invest in either USD Asian credits or local currency credits. Other Asian total return strategies either exclusively invest in USD Asian credits or local currency credits. 8 Source: Asia Development Bank, Manulife Investment Management, June 2019. 9 2019 projected GDP growth rate on a purchasing power parity (PPP) basis. Source: International Monetary Fund, 2019. 10 Source: Bloomberg, Foreign Currency Long-term Rating as of 30 June 2019. 11 Source: Bloomberg, as of September 2019. 12 Source: Financial Times, 1 October 2019. 13 Asia Development Bank, as of September 2019; Financial Times, 1 April 2019. 14 China Daily, 2 April 2019. 15 J.P. Morgan Chase and Company announced in September 2019 that it will gradually add Chinese sovereign debt into its GBI-EM global bond indices. The inclusion will commence on 28 February 2020, and roughly 1% of Chinese sovereign debt (as part of the total index) will be added monthly for a period of 10 months to its GBI-EM global diversified and narrow diversified indexes. Bloomberg Barclays announced that it will add Chinese RMB-denominated government and policy bank securities to the Bloomberg Barclays Global Aggregate Index-this will be phased in over a 20-month period starting April 2019. When fully accounted for in the Global Aggregate Index, local currency Chinese bonds will be the fourth largest currency component following US dollar, euro and Japanese yen. Using January 2018 data, the index would include 386 Chinese securities and represent 5.49% of the index. 16 The J.P. Morgan Asia Credit Index (JACI) is a broad liquid US-dollar denominated Asia debt benchmark. It tracks total returns for actively traded US-dollar denominated debt instruments in the Asia ex-Japan region. 17 Source: Manulife Investment Management and UBS, as of 31 March 2019.
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Important disclosures
Investment Considerations
Any performance information shown is the strategy composite gross of fees, including advisory and investment management fees and other expenses an investor would incur, but net of transaction costs, unless otherwise noted; deduction of such expenses would reduce returns. Past performance is not indicative of future results. Net performance results reflect the application of the highest incremental rate of the standard investment advisory or management fee schedule to gross performance results, unless otherwise indicated. Changes in exchange rates may have an adverse effect. Actual fees may vary depending on, among other things, the applicable fee schedule, portfolio size and/or investment management agreement. For example, if $100,000 were invested and experienced a 10% annual return compounded monthly for 10 years, its ending value, without giving effect to the deduction of advisory or investment management fees, would be $270,704 with annualized compounded return of 10.47%. If an advisory or investment management fee of 0.95% of the average market value of the account were deducted monthly for the 10-year period, the annualized compounded return would be 9.43% and the ending dollar value would be $246,355. Unless otherwise noted, returns greater than one year are annualized; calendar year returns for each one year period end in December. Discrepancies may occur due to rounding.
Performance information shown is generally for discretionary strategies/solutions and managed by an entity which is GIPS compliant and falls under the definition of a corresponding GIPS firm. Some investment strategies/solutions may not be included in a GIPS compliant firm under certain circumstances, e.g., SMA/UMA business in Canada or UMA models in the US.
Any characteristics, guidelines, constraints or other information provided for this material is representative of the investment strategy and is provided for illustrative purpose only. They may change at any time and may differ for a specific account. Such information presented was selected by the firm as a representative account that is deemed to best represent this management style. Each client account is individually managed; actual holdings will vary for each client and there is no guarantee that a particular client’s account will have the same characteristics as described herein. Any information about the holdings, asset allocation, or sector diversification is historical and is not an indication of future performance or any future portfolio composition, which will vary. Portfolio holdings are representative of the strategy, are subject to change at any time and are not a recommendation to buy or sell a security. Top ten holdings information shown combines share listings from the same issuer, and related depositary receipts, into a singular holding to accurately present aggregate economic interest in the referenced company. The securities identified and described do not represent all of the securities purchased, sold or recommended for the portfolio. It should not be assumed that an investment in these securities or sectors was or will be profitable.
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Diversification or asset allocation does not guarantee a profit nor protect against loss in any market. The indices referenced herein are broad-based securities market indices and used for illustrative purposes only. The indices cited are widely accepted benchmarks for investment performance within their relevant regions, sectors or asset classes, and represent non-managed investment portfolios.
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