Sourcing alpha from a developing asset class

With Asia exhibiting strong economic fundamentals at both country and corporate level, the diversity of Asian bond markets can provide wide ranging opportunities, particularly for investors who are overweight dollar-denominated assets and currency. However, despite a strong case for greater allocations to the region, most investors continue to be underweight Asian fixed income, according to Adam McCabe, senior portfolio manager for the asset class at Aberdeen Asset Management.

The key question is whether the compelling valuation story found in the region will be unlocked, says Mr McCabe, although he believes signs are promising. “Policymakers’ focus has changed in Asia,” he explains.

“Until the global financial crisis they were happy to maintain the mercantilist approach, but they have realised that their economies were too sensitive to what happened in the developed world, and now when it comes to fiscal policy, the tools they use are different.

“They are now comfortable with allowing a greater role of currency appreciation – you would have never heard, two or three years ago, a central bank in Asia suggesting they were comfortable with the currency appreciating in line with economic fundamentals. They would have remained silent on the issue and they would have been intervening heavily in the currency markets. They appreciate the need to rebalance, and they are doing something about it.”

Aberdeen has 15 people in its Asian fixed income team, based in Singapore and headed by Anthony Michael. The office manages more than $17bn (€13bn) in assets, including $5bn in a range of Asian fixed income products, a market that is continuing to expand.

However investors are unfamiliar with the asset class, says Mr McCabe, often believing that by investing in global emerging market debt they are accessing Asian markets. “Global emerging market debt is not Asian debt,” he warns. “Yet most of the reasons people want to be invested in global emerging market debt are the Asian reasons. They like the low correlations; they like the growth opportunities; they like the currency valuations. And yet when you look at the composition of most emerging market bond portfolios, they have very little exposure to Asia, and very little exposure to Asian local currencies.”

Not all Asian economies can be termed as emerging markets, explains Mr McCabe, however when it comes to fixed income the asset class itself is still developing and is far from perfectly efficient, creating plenty of opportunities for active managers such as Aberdeen, he believes.

“I think the market that is largest, deepest and most accessible is Korea,” says Mr McCabe. “We think there are definite inefficiencies in the bond market that are worth identifying and exploiting. Korean exporters have greatly benefited from their geographical proximity to China, and they are also benefiting from the hit the won took in the global financial crisis.

“Indeed the won remains cheap on a relative basis, particularly when compared to its largest competitor, Japan. Korean brands used to have to demonstrate their quality – now no-one thinks twice. Samsung and LG now compete with Sony solely on price. And with the yen so strong against the won, it is a significant competitive advantage for Korean exporters.”

Asian fixed income is a diversified asset class, says Mr McCabe, which has grabbed the attention of both foreign and Asian investors, who he claims are turning their back on the Western world and investing into other Asian economies instead.

“There is so much going on in Asia,” he says. “It’s not just China, its not just India, and when we offer products to clients, we don’t have all of our eggs in one basket. We offer a product that covers opportunities in credit, local rates and currency, which provide investors with the best risk adjusted outcomes.”