Executive Summary

Asian fixed income has been growing in importance in the portfolios of institutional investors and private banking clients around the world. Based on data from our recent study, Greenwich Associates projects meaningful growth in Asian fixed-income investments in the next 12 months and beyond.

The inclusion of domestic Chinese bonds in the Bloomberg Barclays Global Aggregate Bond Index and other regional industry benchmarks will be an important driver of near-term growth. Over a longer horizon, the continued expansion and maturation of Asian bond markets and investors’ ongoing search for attractive yields in a low-rate environment will fuel further growth.

More than half of the APAC, European and U.S. institutional investors and private banks participating in the study have an allocation to Asian fixed income, with Asian assets making up 18% of fixed-income portfolios overall.

The vast majority of existing investors plan to increase or maintain their allocations to Asian fixed income in the next 12 months, and about one-quarter of current non-investors plan to initiate an allocation during that period. While actively managed or direct investments are currently the most popular vehicle for taking on Asian fixed-income exposures, growing numbers of institutional investors and private banks are using or considering exchange-traded funds (ETFs), which many see as having the potential to enhance liquidity and lower costs.

Executive Summary

Asian fixed income has been growing in importance in the portfolios of institutional investors and private banking clients around the world. Based on data from our recent study, Greenwich Associates projects meaningful growth in Asian fixed-income investments in the next 12 months and beyond.

The inclusion of domestic Chinese bonds in the Bloomberg Barclays Global Aggregate Bond Index and other regional industry benchmarks will be an important driver of near-term growth. Over a longer horizon, the continued expansion and maturation of Asian bond markets and investors’ ongoing search for attractive yields in a low-rate environment will fuel further growth.

More than half of the APAC, European and U.S. institutional investors and private banks participating in the study have an allocation to Asian fixed income, with Asian assets making up 18% of fixed-income portfolios overall.

The vast majority of existing investors plan to increase or maintain their allocations to Asian fixed income in the next 12 months, and about one-quarter of current non-investors plan to initiate an allocation during that period. While actively managed or direct investments are currently the most popular vehicle for taking on Asian fixed-income exposures, growing numbers of institutional investors and private banks are using or considering exchange-traded funds (ETFs), which many see as having the potential to enhance liquidity and lower costs.

Introduction

The fast growing Asian fixed-income markets have attracted investors from the region and abroad. The majority of participants in the recent study invest in Asian government and/or corporate bonds, and a large share of those investors plan to increase their allocations in the next 12 months. Meanwhile, about a quarter of current non-users of Asian fixed income plan to invest in the asset class over the next year.

Two major trends are driving this expansion:

  1. Global interest rates have been lingering at or near historic lows for the better part of a decade. For investors around the world, Asian fixed income represents a rare source of yield. Opportunities to source yield via investments in Asian bonds have become even more attractive since the U.S. Federal Reserve’s decision to end its monetary tightening program and put off additional interest-rate hikes.
  2. Asian markets are becoming more mature and more deeply integrated into the broader universe of global fixed income. The culmination of this process has been the inclusion of Asian bonds in popular benchmark indices—a move that will open the doors to a new wave of investors.

Based on the results of the study, we will assess the appetite for Asian fixed income among institutional investors and fund distributors in Asia-Pacific, Europe, and the United States, examine which vehicles investors are using to obtain exposures, how investors are managing these assets within their portfolios, identify the key drivers of investment to date, and project future demands.

Global Allocation

Asian assets make up about 18% of global institutional and private banking fixed-income assets, a total that breaks down to 5% Asian government bonds and 13% Asian corporate bonds.

allocations asian bonds global fixed income portfolios

As one would expect, the biggest allocations are found among Asia ex-Japan investors. Asian institutional investors allocate 26% of total fixed-income assets to Asian bonds, splitting between Asian corporate bonds (16%) and Asian government bonds (10%). Asian private banks show an even stronger demand for the asset class: 51% of fixed-income assets are allocated to Asian bonds, with the majority in corporate bonds (46%) and a small allocation to Asian government bonds (5%). At the country level, intermediaries in Hong Kong allocate 63% of total fixed-income assets to Asian fixed income, including 12% to Asian government bonds and an impressive 51% to Asian corporates. Intermediaries in Singapore are not far behind, with allocations of 44% to Asian corporate bonds and 2% to Asian government bonds.

Allocations in other regions are more modest but growing, as we will discuss in more detail later in this report. European investors make the biggest allocations outside of Asia ex-Japan, with about 4% of total fixed-income assets invested in Asian government bonds and roughly 3% allocated to Asian corporates. U.S. investors invest almost 5% of overall fixed-income assets in Asian government bonds, but allocate less than 1% to Asian corporate bonds. Japanese investors allocate about 1% of fixed-income assets to Asian government bonds and slightly more than 2% to Asian corporate bonds. Australian investors allocate about 1% of fixed-income assets to each.

breakdown asian government bond portfolios

A Broadening Investor Base, Expanding Allocations

Forty-one percent of the current investors participating in the study plan to add to their allocations in Asian fixed income in the next 12 months, and 54% plan to maintain existing allocations at present levels over the same period. We are projecting a continued pickup in aggregate demand for Asian fixed income in the next 12 months.

Among institutional investors residing in Asia ex-Japan, about one-third of current investors expect to increase allocations to Asian fixed income in the coming year, with slightly less than two-thirds planning to hold allocations steady at current levels, and only 3% planning reductions. Given that Asian fixed income already makes up such a large portion of these portfolios, follow-through on these plans would equate to significant net inflows. Those flows should get an additional boost from fund intermediaries in Asia ex-Japan, nearly 40% of which plan to increase allocations, while 56% plan no change and only 5% plan reductions.

Furthermore, not a single study participant from the U.S. or Europe expects to cut existing allocations to Asian fixed income in the coming year. Half plan to hold allocations steady at current levels while the other half plan to increase. Those expectations likely reflect two factors: 1) The decision of central bankers in Europe, and more recently in the U.S., to hold interest rates at current low levels, and 2) The maturation of Asian bond markets, in particular China—now the world’s third largest bond market behind only the U.S. and Japan—culminating in the inclusion of domestic China bonds into global indices.

asian fixed income attracting investors

Future demand for Asian fixed income will also be augmented by the entry of investors who have not traditionally been investing in Asian fixed income. One-quarter of non-users plan to start investing in the next 12 months. “In an attempt to find new areas to invest in, we are interested in Asian fixed income as the next candidate,” says a respondent from a Japanese bank planning its debut investment in the asset class. “Our interest is in governments denominated in USD, and probably we will start with fund investment.”

The adoption rate could be highest in the local Asia ex-Japan market, where 30% of institutional and three-quarters of intermediary distributors who currently do not have Asian fixed-income investments plan to start investing in Asian fixed income in the coming year.

More than Just Cyclical

Given the low interest-rate environment and bond yields in many of the developed markets, it’s important to consider whether this increasing demand for Asian fixed income is a cyclical phenomenon reflecting a short-term yield play, or a secular shift in portfolios and portfolio strategies.

On this point, the study results are unequivocal. Globally, only 3% of study participants with plans to increase or initiate allocations to Asian fixed income say these investments reflect tactical decisions, meaning that their investments will be short-term in nature, or held for less than one year. In contrast, half of these respondents say their investments will be strategic, or held for more than one year. These results strongly suggest that the increased demand is not just another cyclical rotation into emerging markets or higher yielding securities, but rather represents a more secular shift in investment strategies, with yield and diversification in view.

In the next sections of this paper, we’ll analyze the forces driving this secular shift by examining the primary reasons institutional investors and private banks say they are increasing their investments in Asian fixed income, and the ways investors are implementing and employing Asian fixed income in their portfolios.

Drivers of Demand

Investors attribute their increased demand for Asian fixed income to two general factors:

  1. Given short- and long-term views on global markets, investors see opportunities for outperformance, and
  2. The growth and maturation of Asian fixed-income markets is creating a compelling rationale for increased exposure and making it easier for investors to participate.

Opportunities for Outperformance

The graphic above shows the key reasons institutional investors and private banks around the world give for increasing their exposure to Asian fixed income. By a wide margin, yield is at the top of this list: 

  • “The purpose of our new investment is to discover assets and investment products with higher yields.” ~ South Korean insurance company 
  • “Yield enhancement” ~ Private bank, Singapore 
  • “The fundamentals of Asian bonds have been improving, and their yields are higher than the U.S. Treasuries.” ~ Japanese insurance company 
  • “We were attracted to high yields compared to other developed markets like the U.S.” ~ South Korean asset manager

As the following pie chart shows, when it comes to local-currency Asian government bonds, more than three-quarters of study participants say they target at least 100 basis points (bps) of yield enhancement over U.S. Treasuries, and nearly one-third of respondents say they are looking for a pickup of more than 200 bps.

alpha target vs US treasuries

In addition to basic yield enhancement, study participants say they see performance benefits arising from favorable macro views on Asian fixed income, the potential for currency appreciation and the diversification enhancement for their overall fixed-income portfolios. As a study participant from a Dutch insurance company explained, “Most of these allocations are EUR investment-grade issues from Asian corporates, which helps us to have a better diversification in our EUR investmentgrade credit portfolio.”

A Maturing Market

The second major driver of increased investment in Asian fixed income is the maturation of Asian fixed-income markets, including both the rapid growth and development of local Asian markets, and the continued integration of these markets into the broader universe of global fixed income.

Among the top reasons given by study participants for increasing their exposures to Asian fixed income are inclusion of Asian fixed income in global indices (41%), growing market size/expanded product choices (37%) and improved market liquidity (24%). These responses align with additional data on the criteria investors use when considering investments in Asian fixed income.

As shown in the following graphic, liquidity/market depth is the second most common factor considered, behind only yield. Third on that list is the typical credit rating of investable universe of securities. The expansion and development of Asian credit markets in these and other areas is acting as a tailwind for institutional demand, as Asian markets become increasingly liquid and as rating agencies expand their list of rated Asian securities.

key factors considered when investing asian fixed income

When it comes to projecting future demand, these responses are particularly revealing, as shown in the following graphic. Some of the considerations driving inflows into Asian fixed income today are the same factors that have actually discouraged some investors from investing up until now. For example, 28% of study participants who do not currently invest in Asian fixed income list “insufficient liquidity or trading volumes” as a reason for abstaining, while 17% cite “limited product choices.” Those objections are falling away with the introduction of new products and more liquidity.

reasons not investing asian fixed income

Meanwhile, close to a third of institutional investors and private banks that don’t invest in Asian fixed income say they are prohibited from doing so by internal investment restrictions. However, 13% of institutional investors and private banks that are planning to increase their exposures in the next 12 months say they are doing so because they’ve been freed up by the relaxation of investment restrictions within their organizations. We expect this trend to continue. The gradual loosening of internal investment restrictions is a clear reflection of the maturation of Asian fixed-income markets and a sign that investors around the world view the growth and development of these markets as an opportunity to integrate Asian holdings into their broader fixed-income portfolios.

Index Inclusion

Over the next year, one of the most immediate and powerful drivers of this process will be the introduction of Asian fixed income into global bond indices—a factor cited as an important reason to increase existing exposures by 41% of study participants.

Over the course of 2019 and 2020, 364 onshore Chinese bonds will be added to the Bloomberg Barclays Global Aggregate Bond Index. That move marks a key moment in the integration of China’s US$13 trillion bond market into the global fixed-income market—and into the portfolios of investors around the world. “The Chinese market is getting more open to foreign investors, and we now have a freer access,” says a study participant from a Japanese bank. “Absolute returns are our investment goal, so China’s market size and the liquidity are very important for us to be able to trade whenever we need to.”

benchmark asian government bonds

By the end of 2020, onshore renminbi-denominated Chinese bonds will make up 6% of the index. However, as the graphic shows, we are still at the very start of this “inclusion” process. While the Bloomberg Barclays Global Aggregate Bond Index is an important benchmark, 3 of the 5 top indices used by institutional investors and private banks in the study to benchmark Asian government bond performance come from J.P. Morgan. We expect the market to receive an equal or even bigger boost when J.P. Morgan takes the step of integrating domestic China bonds into keystone benchmarks like the J.P. Morgan Emerging Markets Bond Index and the J.P. Morgan Government Bond Index–Emerging Markets. Over the next few years, this process of index inclusion will represent a powerful source of demand for Asian fixed income, as investors around the world adjust portfolios to replicate indices and invest in index mutual funds and ETFs that provide index exposure.

appetite china driving demand

Portfolio Management

Even as Asian fixed income becomes more integrated with global markets, investors are still working to determine how best to obtain exposures and structure holdings within their portfolios.

Roughly 30% of investors in the study manage Asian fixed income as part of a global fixed-income portfolio. Between 25% and 30% obtain Asian fixed-income exposure through a global emerging market portfolio. A similar proportion of investors have established standalone Asian fixed-income portfolios.

management asian fixed income

However, standalone Asian fixed-income portfolios are found almost exclusively in Asia. Unsurprisingly, no study participants from Europe, the U.S. or Australia maintain Asian fixed-income allocations this way. Australian investors are most likely to include Asian fixed income in a global fixed-income portfolio. Most U.S. and European investors group Asian fixed income into a global emerging market fixed-income portfolio.

ETFs Gain Popularity as Vehicle for Asian Fixed-Income Exposures

Although most study participants obtain their Asian fixed-income exposures through direct investments, segregated mandates or mutual funds, a growing numbers of these investors are using or considering ETFs as a liquidity-enhancing alternative.

investment vehicles used asian fixed income

As the graphic shows, 58% of study respondents currently get Asian fixed-income exposures through direct, active investments. Active segregated mandates and active mutual funds are the next most popular vehicles, employed by 36% to 37% of current investors. “We outsource to managers for better efficiency, and we generally prefer fund vehicles because of better returns in terms of dividend,” explains a study participant from a Hong Kong insurance company.

ETFs currently rank fourth among vehicles used to gain exposure to Asian fixed income, overall, with about one-quarter of global study participants using ETFs for the asset class. “For bigger portfolios we have a line-by-line approach, buy and hold, with direct, passive investments,” says a study participant from a Dutch institutional fund. “For a smaller portfolio, we choose to diversify with an ETF.”

ETFs are the most popular passive vehicle among study participants, and are gaining traction in Asian fixed-income portfolios. Twenty-two percent of respondents indicate they are considering an investment in Asian fixedincome ETFs—topping all other vehicles. ETFs may soon approach active mutual funds in terms of popularity as one of the most used vehicles for Asian fixed-income investments.

The following graphic shows the perceived benefits that are attracting investor attention to Asian fixed-income ETFs. Tops on the list is liquidity. A fixed-income ETF is at least as liquid as the underlying market that it tracks. The unique structure of a fixed-income ETF—which packages a diversified portfolio of bonds into a single, tradeable equity—provides two sources of liquidity for investors. “Primary” sources, which can be accessed via an authorized participant, along with “secondary” sources, which can be accessed directly, define a fund’s overall liquidity profile. Growing numbers of institutional investors and private banks see the addition of ETFs, with their ease of trading on exchanges intraday and through the creation/redemption process in the primary market, as a means of addressing liquidity concerns and enhancing the liquidity of their overall bond portfolios.

benefits asian fixed income etfs

Investors in the study also value ETFs for their ability to deliver diversification in a single trade, and the fact that ETFs can represent a lower-cost alternative to other vehicles due to their relatively low expense ratios and transaction costs.

Conclusion

After decades of development and years of rapid growth, Asian bond markets have now matured in terms of both breadth and depth, and have the liquidity and infrastructure needed to meet the requirements of an expanded universe of investors. This progress is reaching a tipping point with the inclusion of domestic China bonds into one of the industry’s important index benchmarks. As other index providers follow suit, this integration will open the door to a wave of new investors and investment assets.

That’s good news for investors around the world, who are now able to more easily access the asset class for a source of much needed yield, invest in a region with bright long-term growth prospects and diversify from traditional fixed-income investments. New and existing investors are currently working to determine where best to house Asian fixedincome assets in their portfolios, and which vehicles and strategies to use to gain Asian exposures. As they do so, ETFs are emerging as a relatively low-cost means of obtaining liquid exposure to Asian fixed income.

Methodology

Between October 2018 and March 2019, Greenwich Associates interviewed 187 institutional investors and gatekeepers at private banks in a study commissioned by ABF Pan Asia Bond Index Fund (PAIF, an ETF managed by State Street Global Advisors) on Asian fixed income. The research sample was made up of 151 institutional investors and 36 intermediary fund distributors from Asia-Pacific, Europe and the United States.

respondents