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Asian local currency bond market 'little gem'

Thursday 26th August 2010
Investors are underestimating the opportunities for Asian local currency bond markets, according to Rajeev de Mello, Head of Asian Investments at Legg Mason affiliate Western Asset Management.

He said: "The Asian local currency bond market is actually twice the size of the UK bond market and the fourth largest globally, following the US, the euro zone and Japan.

"Despite this, few investors have picked up on the significant transformation of the asset class. In fact, continued improvements in economic fundamentals have led the vast majority of the region's sovereign debt to be upgraded to investment grade.

"The region continues to offer investors the opportunity to pick up higher yields in countries such as Indonesia and the Philippines, which are still rated below investment grade. Similarly, many investors perceive Asian local government bond markets to be a homogeneous asset class, but overall returns, the drivers of performance and volatility differ significantly by country within the region, providing investors with attractive investment opportunities."

Western suggests the asset class as a whole offers investors an attractive risk/reward trade-off compared to other sectors of the global fixed income universe such as emerging market hard currency debt or global high yield. And despite Asian bonds having generated strong returns over the past year, the asset class still offers attractive yields compared to other regions. Furthermore, better management of government finances and more disciplined monetary policy through the widespread adoption of inflation targets has reduced the volatility of bond market returns across Asia.

De Mello said: "The potential for currency appreciation is one of the aspects that makes the asset class compelling to foreign investors. Indeed, the gains in productivity that are fuelling strong economic growth in the region is one factor driving the structural appreciation of Asian currencies, which will add to the total returns generated for foreign investors.
"The recent news regarding a change in China's currency policy, allowing a gradual appreciation of the Yuan, is likely to encourage similar appreciation across much of Asian, adding to the positive currency outlook."

He added: "Investors shouldn't mistakenly believe that Asian bond returns are largely driven by the currency returns. In fact, bond returns were by far the largest driver over recent years, with currency returns merely amplifying those gains.

"The issuance of local currency bonds by governments has increased significantly over the past decade. While the development of bond markets started from a very low base in some countries, the expansion of bond issuance was driven by factors such as strong economic growth and, more recently, increased supply in order to finance government stimulus programmes during the global credit crisis.

"As the region is barely represented in global bond indices and therefore in global bond portfolios based on them, more focused Asian bond funds provide a good entry point for investors wishing to allocate a proportion of their portfolio to the asset class."

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Mike Jones

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