We asked this year’s most Astute Investors to identify the overriding concerns for the Asian G3 bond market over the next 12 months from six options: China currency risk, default risk (naming the sectors of major concern), China policy risk, China slowdown/ hard landing, US interest rate risk and the lack of liquidity. They were also asked to highlight what strategies they would use to maintain their funds’ performance in light of these concerns.

HONG KONG

Desmond How
Nomura Global Capital Management
Major concerns: The commodity supercycle is over as China structurally slows down marginal buying. A new pricing norm could prove onerous for less competitive producers, hence the default risk.
Strategies: Stay tactically short as emerging markets look set to extend bear credit cycle.

Arthur Lau
PineBridge Investments
Major concerns: Different sectors/issuers may face different risks. I think issuers that are sensitive to commodity prices may face a bigger challenge in refinancing their debts in the near to medium term given the unfavourable sectoral and profitability outlook in this cycle. While some may have more funding alternatives or time in dealing with this situation, some will likely face debt restructuring in the near term especially those who have restructured historically in the past. At the moment, I do not see a significant rise in defaults yet. However, as profit margins continue to be pressured and the likelihood for Asian FX to remain depreciative against USD, we may see some borrowers’ repayment ability sharply decline in a short period of time.
Strategies: Given that we are long only, we are not able to use active hedging alternatives to protect the performance. Nevertheless, apart from raising cash levels to lock in gains, we could also hug along the benchmarks more closely and/or reduce portfolio beta proactively in this cycle especially before the US rate decision is finalized.
SINGAPORE

Ronie Ganguly
PIMCO
Major concerns: The Asia region is currently in the slow lane of a multispeed global economy, creating what PIMCO has identified as a ‘new normal’ trend. The region is undergoing a fragile transition, with China especially grappling with the transition from export and investment-led growth. The rest of the region is struggling to adjust growth models in the ‘new normal’ environment. We believe there are daunting challenges to manage structural adjustment in leveraged economies – and the path of transition will be bumpy with chances of economic and market shocks. Additionally, we see diminishing returns as a result of unconventional monetary policies, especially in an environment of widening divergence between regional and global growth profiles.
Strategies: Implementing liquid alternatives with compelling valuation amidst considerations of diversification pose some of the most challenging investment objectives in the current turbulent markets. Over reliance on central banks has led to a wedge between valuations and fundamentals and we are paying more attention to risk positions and stress tests. Risk premiums in general have been compressed, but as long-term investors, we believe that volatility creates opportunities. We remain focused on some of these opportunities to spot lucrative assets at favourable prices. Some of our Asia strategies involve focusing on income generation, using dollar hedged strategies to take advantage of secular US dollar strength, as well as keeping our strategic exposures to China and focusing on the secular Indian growth story.

Mark Thurgood
Saka Capital
Major concerns: Asia has traditionally been financed by bank relationships, with bond markets being used opportunistically by issuers. The surge in bond supply in recent years has been coupled with greater regulation and a focus on bank capital usage by the sellside. This leaves the market more ‘gappy’ in nature as the two-way liquidity to help smooth the repricing of risk can be absent both in sell-offs and rallies. While concerns over the size of the ‘door’ in the event of a sizeable rotation out of credit by investors have not been tested to-date, the lack of liquidity in the few sell-offs this year is noteworthy.

Salman Niaz
Goldman Sachs Asset Management
Major concerns: China slowing down has ramifications for Chinese credit quality as well as regional growth and the resulting credit quality. China has become the biggest economic and capital force in the region and the Chinese slowdown has meaningful regional and risk implications.

INDONESIA

Ezra Nazula
Manulife Aset Manajemen Indonesia
Major concerns: The Indonesian USD bond market will continue to be heavily correlated to the US Treasury yield movement. With expectations looming of a Fed rate hike and higher trajectory for US yields, any adverse movement will affect the Indonesia sovereign bonds.

Wiman Kastami
BNP Paribas Investment Partners
Major concerns: Further yuan devaluation due to the slowing economy and Fed behind the curve.
Strategies: Increase cash level and focus on USD assets.

MALAYSIA

Jason Wong
Hong Leong Bank
Major concerns: We are concerned about China. China is so big that when she sneezes, the Asian region will catch a flu. Economic indicators suggest a sharp slowdown, and that creates uneasiness particularly after having seen China, over the last half a decade, experience fast credit growth. Corporate China has levered up their balance sheets (and so have local governments and households), the shadow banking has not dissipated (it has just morphed from one form to another), and now NPLs in the banking system are on a rise. Credit market trading liquidity is the other area of concern. Trading liquidity has dwindled over the last few years, and dealers now carry a lot less inventory. That has effectively made market participants more polarized in terms of trading patterns, and such herd mentality results in markets becoming unnecessarily more volatile.
Strategies: We acknowledge the market trends, and would formulate our strategies towards a 40-60 split between less liquid bonds (for carry income) and liquid bonds (for funding liquidity).

Esther Teo
Affin Hwang Asset Management
Major concerns: China’s faster than expected slowdown and any policy mishap could cause more volatility and sell-off in risky assets. We cannot rule out further yuan devaluation which would have further implications for Asian currencies and Asian credits with a large USD debt exposure. The lack of liquidity in trading credit is also a source of concern as the market is not functioning normally.
Strategies: Keeping to quality credit and active asset allocation is key to riding through the volatile market. We also employ various hedging strategies to mitigate interest rates and currency risks.

PHILIPPINES

Nadine Alapan
Banco de Oro
Major concerns: Events in China such as the equity market sell-off, CNY devaluation and weak data continue to be the main drivers of market volatility. Despite the introduction of new policy measures, growth concerns remain the key issue and drag market sentiment. The Fed lift is still a growing concern for EM economies as fundamentals in some EM countries are quite challenging and vulnerable at the moment. Higher interest rates will negatively impact the growth of EM economies.
Strategies: With expectations of a Fed lift off, we remain neutral on duration to mitigate any sudden major changes in the yield curve.

Rainier Tiam-Lee
Metrobank
Major concerns: 2015 has definitely been a roller coaster ride. Gains for most asset classes have pretty much evaporated (save for a select few) due to market volatility and concerns over global growth. August and September were especially painful for most traders, asset managers and investors alike amid the devaluation of the yuan, the depreciation of other EM currencies and the global stock market rout. While the hard landing of China is partly to blame for a lot of the recent pressures in the financial markets, I believe there are more pressing concerns than that. First, the threat of a potential rise (emphasis on the word “potential”) in US interest rates is pushing everyone’s panic button. This has hit EM currencies hard and has forced the hand of other central banks to act and maintain the competitive strength of their currencies. This in turn has led to bigger risks in credit and the premium to pay for protection sky rockets, or bonds tank as a result. Second, whether the Federal Reserve decides to raise rates this year or not, the uncertainty has created a drought in liquidity. No bids when prices tank, no offers when markets rally. Balance sheet constraints have also limited market liquidity and every dealer has to live with that. Finally, we have seen the big drop in equities and currencies, however credit remains fairly resilient. But the threat or risk of default by corporations and sovereigns, partly due to the large drop in commodity prices, is real and I believe everyone should be aware of it.
Strategies: Sometimes the best way to trade in a volatile market is to go back to the basics. Safe haven assets like US Treasuries and German bunds have performed well in the second part of this year and should continue to do so in any risk-off environment. Buying protection has also worked well this year. Despite some basis risk, their levels have moved much the same way as bonds have performed against benchmarks. Ultimately, though, it’s about staying nimble. 2015 will remain pretty volatile since a possible rate hike is still on the table. Staying patient when picking levels, taking profit whenever possible and going for lower duration should preserve some PNL or make you some more. 2016, I believe, should present a better opportunity for everyone. The FOMC’s promise to keep the pace of rate increases gradual, continued accommodative policies from the EU to Japan, and a possible rebound in commodity prices in the latter part of the year should bode well for G3 bonds.

Analen R Reyes
Banco de Oro
Major concerns: Markets should continue to be driven by the pace
of the Fed policy normalization and the slowing growth trend in China and its concomitant effects on regional and commodity markets. This should continue to result in volatility in the coming months. However investors should be able to find opportunities to scale into better quality names.

TAIWAN

Chia Tse-Chern
Nomura Asset Management
Major concerns: The market will melt down if the RMB depreciates sharply.
Strategies: Keep cash, overweight sovereigns, avoid local currency bonds.
UK/EUROPE

Alistair Ling
GLG Market Neutral Fund
Major concerns: Fixation with central bank liquidity shows how traditionally different classes of investors are converging on the same investment decisions. Current market levels owe more to central bank liquidity and to the suppression of natural risk premia, rather than deep conviction of the value of real investments. A big hurdle is that the concept of ‘capitulation’ doesn’t structurally exist in this market, the street doesn’t have the capacity or willingness to take in the paper, and the flows aren’t two way yet, so it remains a slow drip of paper coming out as opposed to a collapse. Which is why CDS appears to overreact versus cash prices.
Strategies: As liquidity shrinks, it would make sense for investment managers to pull back their market exposures since liquidity is a key component of position risk assessment. I would prefer to defer building large exposure until “creative destruction” via insolvencies becomes more visible. In that scenario, where risk and yield seeking gets replaced by capital preservation, valuations can be more amenable to long-term position building.

Amy Kam
GAM
Major concerns: China is a heavily regulated market. How China will sail through its economic transformation and rebalancing without major disruption and dislocation remains to be seen.
Strategies: Reduce duration, and
hedge risk on weaker EM names that are further up the commodity supply chain.

Richard Lange
Stone Harbor Investment Partners
Major concerns: In a market offering limited liquidity, further renminbi weakness is likely to cause another bout of volatility affecting the entire credit spectrum.
Strategies: Bottom-up credit review and constant monitoring of credits via on-site visits and discussions with management.
US

Javier Segovia
TCW
Major concerns: I believe there is a low probability of a Chinese hard landing and a higher probability of a slowdown. The ability of the Chinese government to proactively address its macro- and microeconomic challenges will be critical. The government has correctly used a variety of policy tools to stabilize certain sectors, like the property market. In terms of US monetary policy, the delay in hiking US rates has allowed countries like India to implement a steeper rate cut than would otherwise be possible. This is positive for risk assets and liquidity conditions in the region.
Strategies: We are not using any alternative or derivative strategies. We have adopted a more cautious posture with sectors that could be negatively affected by higher interest rates and/or a weaker local currency.

John Espinosa
TIAA-CREF
Major concerns: One of our biggest concerns for the Asian G3 bond market over the next 12 months
is the prospect of a China slowdown or hard landing. Though we are seeing some near-term signs of stabilization in Chinese growth, a sustained slowdown would weigh negatively on global growth and trade given the modest US
economic recovery to date, and uncertain trajectory for Europe
and Japan. Emerging Asian economies and global commodities remain highly sensitive to a China slowdown through the trade channel in particular.

Eric Chung
Oppenheimer Funds
Major concerns: China was supposed to be the white knight whose growth was going to bail out the general lack of global growth. But it turns out there may be more smoke than substance. No one in the world really knows what the Fed is going to do now. It’s not rate risk per se as I believe we will remain lower for longer, it’s more the lack of clarity between the market and when the Fed will finally act that has become the issue. No one knows what they’re going to do and when – I feel like they’ve lost credibility and that has led to a great deal of volatility in my opinion. Trillions of dollars of credit growth in the QE era. Too much credit too fast and nowhere for it to go in a bad scenario. We’ve seen some of this in the recent EM-led wobble – banks’ hands are tied and asset managers are sellers with very few homes for the risk.
Strategies: Aggressive hedging strategies and active, tactical trading strategies.

Editor’s note: Astute Investors that ranked within the top 5 were invited to express their views. These award-winning individuals are presented in rank order by region. Their responses were gathered in September and October 2015. Please contact [email protected] for any amendments to names.