Asian Sovereign Bonds: The New ‘Safe Havens’?

February 18, 2013Asiaby QFinance

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Asian Sovereign Bonds: The New ‘Safe Havens’?

As U.S. and European markets continue to sputter amid the global economic uncertainty, emerging market bonds in Asia have been quietly gaining favour as alternative safe havens – with relatively strong security, yet attractive yields. Experts however are worried whether a massive surge of money may end in a crash; though, for the moment at least, Asian sovereign bonds are showing surprising resilience.

Asian bond markets still have some way to go to achieve the levels of the US and European bond markets, but according to a recent paper by three Bank of International Settlements (BIS) economists, they are already being regarded by investors as something of a "safe haven" in difficult times.

The BIS view is supported by data from the US research house EPFR Global. It found that funds focused on Asian emerging market bonds attracted some $14.4 billion in the first quarter of 2012, by comparison with just under $2 billion last year.

And according to a CNBC report, the average yield on a local bond benchmark such as the HSBC Asian Local Currency Bond Index is between 4-5 percent. This is a very attractive yield at a time when US Treasuries are yielding below 0.6 percent and the yield is all the more attractive when you consider the very benign government debt position of some emerging markets.

CNBC points out that Indonesia's public debt amounts to less than 25 percent of GDP while a good deal of its growth is driven by strong domestic consumer demand rather than by exports. The Indonesian rupiah 10-year bond pays some 6.05 percent, for example.

The BIS report, by the Bank's chief economist, Ken Miyajima, and two of his colleagues, M. S. Mohanty and Tracy Chan, starts from the premise that what were once considered to be safe assets, such as US treasuries, or UK and German bonds, are no longer viewed as either particularly safe or particularly rewarding, by large numbers of investors.

This means that the pool of "safe haven" assets is shrinking dramatically and investors are having to think laterally and to look elsewhere. In the hunt for yield plus security, these disillusioned investors have discovered the local Asian bond markets and are piling in. As a result, these bond markets are now paralleling established "safe haven" markets in the way they perform through crises, and are showing surprising resilience.

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This in turn creates a virtuous circle and encourages more investors in advanced markets to move an increasing portion of their assets into emerging market bonds. In their paper, the BIS authors look at whether emerging market local currency bonds are actually "safe havens" or only seem so. One of the questions that preoccupy the authors is whether the recent surge (in money pouring in to EM bonds) is likely to end in a crash, as has happened in previous episodes of crises in EM economies.

For an asset class to be considered a safe haven it needs to satisfy at least two crucial conditions. First, how correlated is it with other asset classes? Second, to be attractive returns in that asset class, and price behaviour generally, should not be too volatile. Investors need to be able to anticipate returns without having to peer through a fog of uncertainty.

So are emerging market bonds now resilient enough to be a "safe investment"? As the BIS points out, to be an attractive safe haven, you really want a particular asset class to be only weakly correlated with other asset classes, so they don't all plunge together in a crisis. So you want EM bonds to be determined more by local, domestic factors than by global ones. Second, you want the sovereign debt that you are investing in to be able to absorb the various shocks that buffet the global economy from time to time, without falling over.

Today, the domestic government bonds of five EMs are listed as part of the widely used Citigroup 23 country World Government Bond Index (WGBI). The BIS authors argue in their paper that EM bonds are in fact demonstrating that they are more influenced by domestic rather than global factors, which is good, and that they are exhibiting quite a bit of resilience.

The upshot is that we are likely to see far stronger flows into EM bonds over the next few years, which will further boost the ability of emerging market economies to build out their economies and infrastructure, making the bonds still more attractive. The world, as they say, is changing...

By Anthony Harrington

Anthony Harrington is an award-winning business and energy journalist, writing regularly for the Scotsman newspaper, the Glasgow Herald newspaper, Financial Director magazine, Pensions Insight magazine, CA Magazine, and a number of other publications. He won Business Finance Journalist of the Year 2006, Institute of Financial Accountants, and Journalist of the Year, State Street 2006 Institutional Press Awards, and was runner up in 2007 and 2008.

Local Sovereign Bonds in Emerging Markets- a "Safe Haven"? is republished with permission from the QFinance Blog. Get the QFinance Dictionary of Business and Finance iOS app for a comprehensive guide to financial terms and expressions.

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