As with any major policy shift, the first US rate hike since 2016 is likely to set off market volatility. While investors may have already processed the possibility, the challenging part remains: how to position for this pivot?
Rising rates call for robust risk management, as bond values typically fall. For investors with greater flexibility to navigate the global fixed income markets, Asia bonds offer a differentiated risk profile that, we believe, would make them valuable and timely holdings to insulate global portfolios from these risks.
Duration management
Overweighting short duration is one of the primary strategies to mitigate interest rate change risk. The longer the bond's duration, the more its value is likely to fall as interest rates rise. Therefore, holding shorter-duration bonds helps lower the volatility of bond prices in a portfolio.
Asia bonds offer the advantage of shorter duration than US and Global Aggregate peers, both in the investment grade (IG) and high yield (HY) segments. For example, Asia IG has approximately three years shorter duration than US IG, but offers incremental yield. Similarly, a comparison of US HY and Asia HY highlights the latter's shorter duration, but with nearly double the yield.
This higher yield/shorter duration profile potentially offers wider room for spreads to tighten and help absorb rate changes. Active duration management at the portfolio and security level, adjusted according to the direction of interest rates, should minimize the risk of erosion in bond values and potentially enhance returns.
Asia Duration Is Shorter Than Peers' With Better Yield
Source: Bloomberg, PineBridge Investments as of 15 February 2022. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Duration is a measure of the bond's sensitivity to changes in interest rates. Yield refers to the rate of return if bonds are held to maturity. The rate of return includes the coupon payments received during the term of a bond and its principal repayment upon maturity.
Low correlation to US Treasuries
Over the medium to long term, we believe the rising rate cycle will have a moderate impact on Asia credit. Over the past 10 years, the sensitivity of Asia investment grade bonds to interest rates measures at 0.5 R-squared, which indicates it is moderately correlated.1 Within Asia high yield segment, the sensitivity is negligible at 0.0003. This suggests that holding Asia bonds should be more favorable than US bonds, particularly at the beginning a rate hike cycle.
Historical Correlations Between Asia Bonds and US Treasuries
Asia HY vs. 5 Yr UST - negligible correlation
Asia IG vs % 5 Yr UST - moderate correlation
Source: Bloomberg, PineBridge as of 31 January 2022. JACI refers to the J.P. Morgan Asia Credit Index. YTW refers to yield to worst, which refers to the lowest possible yield you may receive on a bond assuming the issuer does not default. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
Credit spreads for the high yield sector continue to trade at historically wide levels due to ongoing concerns within the China property space. But with ultra-low correlation to US Treasuries, the wider credit spreads within the segment should provide a buffer to offset the rise in interest rates.
This post is funded by Pinebridge Investments
Footnote
1 The higher the R-squared number, the more correlated the asset is.
Disclosure
Investing involves risk, including possible loss of principal. The information presented here-in is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
