Asia ex-Japan bond funds see highest outflows of the year in May as rate hikes, war in Ukraine and Covid rattle risk appetite

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Asian bond funds ex-Japan posted the largest net outflows since the start of the year in May as investors were discouraged by lower expected yields amid rising US interest rates, risk papers even weaker ones such as government bonds being avoided.

Net outflows from bond funds totaled $6.3 billion for the four weeks to May 25, according to data from EPFR Global. The bulk of the buybacks came from investment grade bonds, or rated BBB- and above by rating agency S&P, and Baa3 and above by rival Moody’s.

The outflow comes as foreign investors have reduced their holdings of Chinese government bonds this year, with outperformance in 2021 due to a higher and more attractive yield versus US Treasuries which will reverse. in 2022, according to fund managers.

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Interest rate hikes in the United States have historically contributed to outflows from Asian emerging market bonds. But this year, an inflationary spiral and worries about growth caused by Russia’s invasion of Ukraine and China’s Covid-19 shutdowns have worsened outflows, fund managers said.

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“As financial conditions tighten in the United States and Europe – the latter being Asia’s biggest buyer of sovereign bonds – investors are focusing on capital preservation,” said Ales Koutny, portfolio manager. emerging markets at UK asset manager Janus Henderson Investors.

Investors are selling Asian assets and reinvesting the capital in highly liquid bonds in their local markets, such as Treasuries, he said. The market currently expects the US Federal Reserve to raise rates to 2.65% by the end of the year, from 0.75% to 1% now.

Outflows of Chinese government bonds stood out as foreign investors’ holdings fell by 203 billion yuan ($30.5 billion) to 3.48 trillion yuan in the first four months of this year, according to data from ChinaBond.

Until recently, overseas fund managers were keen to include onshore Chinese government bonds in mutual funds and exchange-traded funds, as the 10-year yuan bond yielded 3.36% at its late peak. February 2021, compared to 1.56%. yield paid by the 10-year US Treasury note.

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That comfortable margin disappeared earlier this year, with the Chinese government bond yielding less than its US counterpart. Both assets were yielding about the same, at around 2.8%, on Tuesday.

Recent Covid shutdowns in China have added to pressures on the Chinese economy. While the central bank has made efforts to ease monetary policy, going forward it will focus less on injecting liquidity through policy rate cuts, said Hong Kong-based Freddy Wong, chief executive. fixed-income securities for Asia-Pacific at the American investment manager Invesco.

“We are waiting for the [Chinese] The central bank is more focused on easing credit than easing liquidity, to stimulate the economy, and that will limit room for further declines in government bond yields,” Wong said. .

This would be bad news for investors who already hold Chinese government bonds in their existing portfolios, because if the yield does not fall further, it will ruin the prospects for bond price appreciation, given the inverse relationship between the bond prices and yield.

But fund flows could stabilize in the coming months as the sharp correction since the first quarter has also brought valuations back to more reasonable levels, said Christy Lee, senior bond portfolio manager at AXA Investment Managers.

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Asian investment-grade bonds now boast more attractive yields than their U.S. counterparts, rewarding investors with about 50 basis points more than the latter, although overall Asian bond maturities tend to be shorter, Lee said. .

Lee currently prefers investment-grade bonds issued by Asian banks, Chinese state-owned companies and India’s renewable energy sector.

Most investors should continue to steer clear of high-yield bonds, especially after defaults by China’s property sector since last year, said Riad Chowdhury, head of Asia-Pacific at the global trading platform. MarketAxess fixed income line.

“Many global investors could [also] think twice about investing in other Asian high yield bonds if they have lost money in Chinese high yield,” he said.

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