Asian bond markets reach a tipping point

Key takeaways

  • Taken together, ex-Japan, the Asian bond markets have grown rapidly over the past decade, driven by improved credit ratings and economic performance, along with a surge in new issuance. 
  • China’s bond market is positioned to receive a major injection in inflows as the country becomes eligible for inclusion in global bond indexes in Q2 2019.
  • High relative yields, low correlation to other bond markets, and the rise of Asian-based institutional investors are some of the reasons we believe investors may push Asian bonds into global prominence in the year ahead.

Over the past decade, the Asian bond market (which includes primarily local currency bonds but also U.S. dollar, or USD, bonds) has grown rapidly to become one of the largest regional bond markets in the world, with an estimated size of US$13.7 trillion. While still smaller than the U.S. bond market (which remains the world’s largest at US$41.7 trillion), the Asian bond market ex-Japan has already overtaken its Japanese counterpart, expanding at a compound annual growth rate of 13.1% over the past five years—outpacing all other regional bond markets.¹ The region’s USD credit market, in particular, has grown more than fivefold over the past decade and is fast approaching US$1 trillion in market value.²


The Asian bond market has significantly grown over the past five years

Chart comparing the size of the Asian fixed income market (excluding Japan) with Germany, France, the United States, the United Kingdom and Japan. for the five years between March 2013 and March 2018. The Asia ex-Japan bond market grew by more than a third to nearly US$13.7 trillion, beating Japan into second place. The 5-year compound annual growth rate for the Asian bond market was 13.1%. For context, the United States was the market with the second highest 5-year compound annual growth rate, which was 3.2%.

Source: Bank for International Settlements (BIS), Asian Development Bank, European Central Bank, Bloomberg, 2018. All amounts outstanding by residence of issuer. Manulife Investment Management, as of March 31, 2018. Asia ex-Japan includes China. CAGR stands for compound annual growth rate. LHS refers to left-hand side, RHS refers to right-hand side.


Although Asian countries and territories are at different stages of economic development, the region is still largely considered an emerging market (EM) and holds significant weight in EM bond indexes. Today, Asia accounts for the largest regional weight (60.7%) in the J.P. Morgan Government Bond Index-EM Broad Index, indicating the region’s dominance within the world of EM.³ The continent also occupies an increasingly important position within the EM credit space, accounting for nearly 45% of the Corporate Emerging Bond Index, which is priced in USD.⁴

An eye on China: an emerging bond market with vast potential

The growth of China’s onshore bond market is one of the key regional developments in the past decade. The market has doubled in size—growing at a compound annual growth rate of 16.6% over the past five years alone—to become the world’s third largest.⁵

Despite rapid growth, we believe the market remains underdeveloped; specifically, foreign participation remains relatively low. However, this is gradually changing due to growing investor interest, partly  as a result of China’s inclusion in major global bond indexes, as of Q2 2019. As much as US$600 billion of passive funds could flow into the Chinese bond market as a result of index inclusion.

“As much as US$600 billion of passive funds could flow into the Chinese bond market as a result of index inclusion.”

We believe onshore Chinese bonds should be considered by global investors for numerous reasons: their attractive yields, China’s strong A+ sovereign rating, and their unique diversification benefits due to China’s monetary policy cycle running differently from G10 countries and demand being driven by its domestic investor base.


Foreign investment in China’s bond market doesn’t match its global economic power

Infographic showing disparity between China's share in world trade flow and foreign currency holdings in China's bond market. The infographic shows that China's share of world trade flow amounted to 11.5% in 2017. The same figure for the United States was 10.6%, followed by Japan, with a 3.8% share of world trade flow. However, total foreign holdings of the Chinese yuan was only 4% in 2017. By contrast, the total share of foreign holdings in the U.S. dollar in 2017 was 31%, and foreign holdings in the Japanese yen was 13%.
Source: Bloomberg, Central Banks, National Sources, IMF, Haver Analytics, Goldman Sachs, May 2018.

A stable and local ownership base 

Asian institutional investors are key buyers in the region’s USD bond market, providing a stable ownership base for the asset class. Ownership of USD bonds originating from the region among Asia-based investors has risen from 56% to 79% in just five years. In contrast, the share of U.S. and European investors participating in new Asian USD bond issues dropped from 44% to 21% over the same period.³

The rise in Asia-based investors is significant, as they can act as anchors and help to reduce volatility in times of market stress. This, we believe, goes a long way to explaining why volatility among Asian corporate bonds—on a three-year rolling basis—is lower than that seen elsewhere within the EM universe.⁷


Improved credit ratings track economic performance

Asia’s increased prominence in global fixed-income markets is due to the region’s improved credit ratings and dynamic economic performance. Indeed, with the exception of  Vietnam, almost all Asian countries and territories boast investment-grade sovereign ratings and are generally higher rated than other EM regions and many EM stalwarts, including Brazil (BB–), South Africa (BB+), and Turkey (BB–).⁷

Burgeoning foreign exchange reserves partially explain the disparity in credit ratings. The total foreign exchange reserves for Asian countries (US$5.7 trillion) far exceed the combined reserves for countries in Latin America (US$834 billion) and EEMA (US$2 trillion).⁸

The total foreign exchange reserves for Asian countries far exceed the combined reserves for countries in Latin America and EEMA.

EM in general has experienced a challenging year in 2018, largely a result of rising U.S. interest rates and a stronger USD. Nonetheless, we remain  constructive on emerging Asia for the medium term. Indeed, in contrast to the 1997 Asian financial crisis, countries such as Indonesia and India have since adopted a more proactive approach to monetary policy to help navigate market volatility. Indonesia, for  example, has raised rates six times in 2018, while India  has lifted rates twice. As economic fundamentals for both markets remain sound, we believe the currencies and bonds of these two countries hold significant upside potential, which may unlock once sentiment improves for EMs.


Credit ratings have trended upward over the past 10 years

Infographic showing how credit rating changes for countries and territories in Asia has changed between September 2008 and September 2018.  The infographic shows that many Asian countries have improved their credit rating during this period.
Source: Bloomberg, local currency long-term ratings, as of September 30, 2018.


Improving economic fundamentals in India and Indonesia over time

Infographic showing key economic indicators for India. The infographic shows that India posted real growth of 8.2% in the second quarter of 2018, and inflation level was 3.1% in September 2018. It also showed that it had a current account deficit of 1.9% as of June 2018 and had foreign reserves of US$401 billion as of September 2018.
Table showing economic data for India and Indonesia in 1997, 2013, and 2018. The point being made here is that growth in both economies remain robust, inflation has fallen, while current deficit fell even as foreign reserves grew.
Infographic showing key economic indicators for Indonesia. It showed that as of September 2018, Indonesia had US$115 billion in foreign reserves, inflation level was at 2.9% and current account deficit was 2.8%.

Source: Bloomberg, World Bank, as of September 30, 2018.



Attractive real yields provide tailwinds

Real yields are commonly used to assess prospective bond investments. The real yield is simply the nominal yield of a bond (at a given point in time) less the annual inflation rate. We believe it’s important to consider real yields,  particularly for EM, as the nominal yields may be misleading: High inflation rates can mean investors actually earn a negative return once inflation is factored in.

The cases of Indonesia and India are particularly worth noting. Ten years ago, while both countries offered high nominal yields, monetary policies in both countries were also relatively inefficient, which meant higher rates of inflation and lower real yields. Today, we believe both countries have more effective monetary frameworks, driving their bonds to the top of the return table. Of note, Indonesia raised interest rates several times in 2018 to protect its currency amid increased financial volatility, while India also raised rates to stem inflationary pressures. Today, the two countries offer the highest real yields in Asia. 

Finally, investors may also note the range of yields available across different markets in Asia. China and Malaysia, which are both currently A+ rated, can offer attractive real yields given their strong ratings, while mature markets such as Singapore and South Korea, which today are rated AAA and AA, respectively, can still offer competitive, positive real yields above those of similar developed markets. With many real yields in developed markets offering negative returns  (such as Japan and Germany), investors are turning to Asia for higher yields.


Real yields of major global bond markets ex-Japan

Chart showing real yield of major global bond markets. As of September 30, 2018, real yields for Indonesian bonds was 4.92%. while yields for Indian bonds came in at 4.33%. Yields for bonds issued by developed countries are much lower, with the United States at 0.36%. Japanese bonds were yielding -1.17% while German bonds yielded -1.53%.

1 Bank for International Settlements, Asian Development Bank, European Central Bank, Bloomberg, as of March 31, 2018. 2 J.P. Morgan, as of September 30, 2018. 3 J.P. Morgan, as of September 30, 2018. The J.P. Morgan Government Bond Index—Emerging Market (EM) Broad Index tracks the performance of local currency EM government bonds. 4 J.P. Morgan, as of September 30, 2018, total market value of the CEMBI with a market value of US$223.5 billion. The Corporate Emerging Market Bond Index series (CEMBI) track U.S. dollar-denominated debt issued by emerging-market corporations. 5 Asia Development Bank, as of March 31, 2018. 6 Bloomberg Barclays announced that it will add Chinese RMB-denominated government and policy bank securities to the Bloomberg Barclays Global Aggregate Bond Index. The inclusion will be phased in over a 20-month period starting April 2019. When the exercise is complete, the index will include 386 Chinese securities, representing 5.49% of the index based on data from January 2018. 7 Manulife Investment Management, Bloomberg, as of September 30, 2018. 8 Bloomberg, S&P local currency long-term rating, as of September 30, 2018.

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Endre Pedersen

Endre Pedersen, 

Chief Investment Officer, Global Emerging Markets Fixed Income & Deputy Chief Investment Officer, Global Fixed Income

Manulife Investment Management

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