Please read the following important information for First Sentier Asian Quality Bond Fund
• The Fund invests primarily in debt securities of governments or quasi-government organization in Asia and/or issuers organised, headquartered or having their primary business operations in Asia.
• The Fund’s investments may be concentrated in a single, small number of countries or specific region which may have higher volatility or greater loss of capital than more diversified portfolios.
• The Fund invests in emerging markets which may have increased risks than developed markets including liquidity risk, currency risk/control, political and economic uncertainties, high degree of volatility, settlement risk and custody risk.
• The Fund invests in sovereign debt securities which are exposed to political, social and economic risks. The Fund may also expose to RMB currency and conversion risk.
• The Fund invests in debts or fixed income securities which may be subject to credit, interest rate, currency and credit rating reliability risks which would negatively affect its value. Investment grade securities may be subject to risk of being downgraded and the value of the Fund may be adversely affected. The Fund may invest in below investment grade, unrated debt securities which exposes to greater volatility risk, default risk and price changes due to change in the issuer's creditworthiness.
• The Fund may use FDIs for hedging and efficient portfolio management purposes, which may subject the Fund to additional liquidity, valuation, counterparty and over the counter transaction risks.
• For certain share classes, the Fund may at its discretion pay dividend out of capital or pay fees and expenses out of capital to increase distributable income and effectively a distribution out of capital. This amounts to a return or withdrawal of your original investment or from any capital gains attributable to that, and may result in an immediate decrease of NAV per share.
• It is possible that a part or entire value of your investment could be lost. You should not base your investment decision solely on this document. Please read the offering document including risk factors for details.
A monthly review and outlook of the Asian Quality Bond market.
Market review - as at June 2023
Asian Investment Grade (IG) credit returned -0.16% over the month despite spreads tightening 11 basis points (bps) to 173bps. Higher US Treasuries eroded the positive effect from narrower spreads, resulting in the negative performance of the sector. Although the US Federal Reserve announced a pause in rate hikes, a hawkish poise led market participants to believe that more rate hikes might still be in the works for the rest of the year, leading to an upward pressure in yields.
The month began on a good note as US debt ceiling negotiations found a resolution, averting a possible technical default. Asian investment grade credit spreads grinded tighter over the month despite softer economic data out of China. Alibaba Group Holding Ltd’s (BABA) business overhaul progressed with the announcement of leadership changes, which saw two lieutenants of Jack Ma taking on the split roles of longtime chairman and CEO Daniel Zhang. Prices of BABA’s USD bonds remained largely stable over the month. At yields that are relatively high by historical standards, we believe that Asian investment grade credit still offers decent value, though we remain selective in credits that are able to weather a downturn better than the broader market.
Asian IG sovereign and quasi-sovereign bonds saw spreads continuing to edge tighter against a tight liquidity backdrop in the market. In frontier markets, Pakistan secured initial approval for a USD3bil IMF loan at the end of the month, narrowly averting a sovereign default as the country struggles to service its external debt. The IMF approval came with stringent requirements that included demands for the sovereign to increase interest rates, cut budget spending further and raise taxes in an economy that was heading into elections. Prices of Pakistan bonds rallied spectacularly by over 12 points, outperforming the rest of Asian sovereigns.
In continuation of the weak year-to-date trend in primary issuance, the market saw the lowest monthly volume in year-to-date issuance. South Korea remained the only source of steadfast primary market supply, with investment grade corporates such as SK Broadband, Hyundai Capital America and Korea Expressway Corporation coming to the market with USD issuances.
The long duration of the Fund was maintained, though some longer dated positions were pared to keep the Fund’s duration tolerance within limits. In what was a largely sideway moving secondary market, the Fund tactically switched Chinese technology names where spreads looked rich into BBB-rated names where the team felt there was room for further spread tightening. The Fund also closed an underweight in South Korea by participating in Korean corporate issuances.
On a net-of-fees basis, the First Sentier Asian Quality Bond Fund returned -0.86% in June, underperforming its benchmark by -0.70%.
On a relative basis, the Fund underperformed its benchmark as overweights in Chinese property detracted from performance. This was partially offset by the Fund’s exposure in high quality quasi-sovereigns and longer dated credits where spreads tightened over the month. Exposure in local currency bonds and the Japanese yen also detracted from performance.
Q3 2023 investment outlook
2023 has thus far been a more upbeat year than 2022 for Asian Fixed Income, with positive returns year-to-date driven in part by the anticipated slowdown in the Federal Reserve’s pace of rate hikes, as well as China’s border re-opening. This performance looks even more commendable against the backdrop of market uncertainties brought on by the collapse of Silicon Valley Bank and Credit Suisse Bank. In supply technicals, the significant slowdown in primary market issuance for Asian Credit slowed additional price support for credits, as evidenced by the resilience in credit spreads during periods of market stress, such as the US regional banking crisis.
We expect the second half of the year to be constructive for Asian credit markets. It is difficult to fathom 10 consecutive rate hikes amounting to more than 500bps not having any effect on the economy. Despite headline growth data still coming in above expectations, particularly in terms of consumption data, we attribute a large part of this to a sharp increase in household debt in the form of credit card and home equity loans, rather than a robust job market and strong wage growth. In other words, we do not believe a debt-fueled economy is sustainable if interest rates stay elevated. While the US regional bank crisis appears to be contained for the time being, the root trigger of the crisis - risk-free T-bills still yielding higher than deposit rates — remains, leading many to ponder what else remains beneath the seeming calm. The more obvious path to us is that further tightening of credit conditions will restrict economic growth for the foreseeable future.
Debate abounds the US Federal Reserve’s next move. We believe we are close to the end of the current rate hike cycle. With core inflation now below the Fed fund rate, it does give the Fed an opportunity to take a pause, assess the impact of the past year of rate hikes before deciding on their next step. With unemployment rate still near historical lows, we do not believe the Fed will be cutting policy rates this year. Barring a sharp deterioration in economic growth, the dollar may stay strong in the coming quarter as long as it maintains a favorable interest rate differential against the EUR and JPY. Bank of Japan’s next move should be closely watched as any signs of change to their Yield Curve Control policy will have significant implications for the course the dollar’s strength.
The euphoria following China’s lifting of its zero-COVID policy has proven to be short-lived amid faltering economic momentum in recent weeks. Nevertheless, tailwinds from China’s re-opening should continue to benefit the Asian region. The path to recovery will be a winding and bumpy, but coming off a low base, achieving the 5% growth rate for 2023 should be feasible. We believe the probability of large-scale stimulus to be low, but should China’s growth falter, the central Chinese government could implement targeted policy measures to support the country’s economy.
Inflation in Asia is relatively benign when compared to developed markets, giving Asian central banks more flexibility to cut rates to spur growth should the need arise. In fact, many Asian central banks have paused their rate hikes in recent weeks as inflation moderated further. We remain constructive on the region’s longer-term growth prospects as Asian economies continue to move up the value chain in the global economy.
We remain constructive in Asian IG credit while staying selective in Asian High Yield. Despite signs of slowing earnings and weaker economic activity in the region, fundamentals of Asian Investment Grade (IG) corporates remain sound. Considering the mounting macro uncertainty, valuations are starting to look rich, despite modest weakening in Asian IG credit metrics within still solid territory. Nevertheless, high all-in yields well above 5% does makes this asset class attractive from an income carry perspective. Our bias is to look for idiosyncratic and relative value opportunities. In Asian High Yield (HY), survivors in the Chinese high yield property sector may provide short-term trading opportunities. Significant upside returns potentially reside among distressed names who survive the debt restructuring process, and these names could benefit from improvement in pre-sales figures.
Source : Company data, First Sentier Investors, as of end of June 2023
Investment involves risks, past performance is not a guide to future performance. Refer to the offering documents of the respective funds for details, including risk factors. The information contained within this material has been obtained from sources that First Sentier Investors (“FSI”) believes to be reliable and accurate at the time of issue but no representation or warranty, expressed or implied, is made as to the fairness, accuracy or completeness of the information. To the extent permitted by law, neither FSI, nor any of its associates, nor any director, officer or employee accepts any liability whatsoever for any loss arising directly or indirectly from any use of this. It does not constitute investment advice and should not be used as the basis of any investment decision, nor should it be treated as a recommendation for any investment. The information in this material may not be edited and/or reproduced in whole or in part without the prior consent of FSI.
This material is issued by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong. First Sentier Investors is a business name of First Sentier Investors (Hong Kong) Limited.
First Sentier Investors (Hong Kong) Limited is part of the investment management business of First Sentier Investors, which is ultimately owned by Mitsubishi UFJ Financial Group, Inc. (“MUFG”), a global financial group. First Sentier Investors includes a number of entities in different jurisdictions.
To the extent permitted by law, MUFG and its subsidiaries are not responsible for any statement or information contained in this material. Neither MUFG nor any of its subsidiaries guarantee the performance of any investment or entity referred to in this material or the repayment of capital. Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk, including loss of income and capital invested.