Strategic allocation to Asia fixed income

Global financial markets currently endure significant uncertainty. Inflation persists at elevated levels in developed nations, monetary policy trajectories remain uncertain, and complex geopolitical tensions introduce additional challenges. Amid such uncertainty, it is advisable for fixed-income investors to diversify their portfolios.

Asian fixed income offers attractive diversification opportunities backed by robust macroeconomic fundamentals, rapid AI development, ongoing supply chain adjustments and attractive yields. Its outperformance relative to other regions makes a compelling case for considering a strategic allocation to Asia within global portfolios.

This article explores the strategic case for investing in Asian fixed income and the role of Hong Kong dollar (HKD) bonds in this context. The global economy currently faces substantial disruptions, with trade disruptions and concerns about high levels of indebtedness in major economies. Despite these difficulties, Asia remains an economic powerhouse, contributing around 60% of global growth¹.

Simultaneously, Asia offers relatively low inflation compared to many Western economies. Asia is not a homogeneous market. Each market has its own growth story, monetary policy trajectory and credit profile, creating a diverse set of opportunities for strategic and tactical investments that can enhance portfolio resilience. For investors with Hong Kong dollar liabilities, HKD bonds provide high-quality assets denominated in the currency of the obligation.

For US dollar-based investors, Hong Kong’s link to the currency can help limit risk exposure. HKD bonds are typically issued by issuers with strong credit quality, including the Hong Kong government, quasi-sovereign entities, supranational organizations and corporates. Yields in the HKD market are modest, but the market's robust credit fundamentals and contained local inflation lend a defensive character to these assets.

Investors can access this market through individual securities, though institutional minimum sizes and thin liquidity in some parts of the market can pose challenges. Many investors find that funds or exchange-traded funds (ETFs) provide a more practical route to entry. In addition to local currency markets, the Asia US dollar bond market offers diversification benefits for global investors.

This market has demonstrated resilience during periods of heightened global volatility, such as the Covid-19 pandemic, the Ukrainian conflict, US tariff implementation and the energy price shock following the Strait of Hormuz blockade. This resilience can be attributed to the high quality and broad composition of the Asia credit universe.

Approximately 87% of the constituents in the J.P. Morgan Asia Credit Index are classified as investment grade.² The index's composition has become more diversified over time, spreading risk across geographies and sectors. Two key investment themes emerge within Asia credit: supply chain realignment and artificial intelligence (AI).

The "China plus one" strategy, wherein international companies extend supply chains to other Asian economies, and the expansion of mainland Chinese companies' manufacturing operations, particularly in Southeast Asia, drive capital expenditures (capex) and local infrastructure financing. These factors may bolster the regional corporate bond universe, providing greater diversification and value investment opportunities.

The second theme, AI, is transforming the Asian technology landscape. Select Asian technology companies stand to gain from increased AI adoption, with strong momentum in hardware tech, including regional foundry and memory chip companies. These sectors benefit from data centre demand and a memory super-upcycle, with stable fundamentals and manageable capital expenditures.

Although often associated with equities, AI is increasingly relevant to Asian fixed income, expanding the investable universe. Technology now accounts for about 10% of the Asia US dollar investment-grade universe, highlighting the growing importance of tech- and AI-linked assets. Spreads in both investment-grade and high-yield markets have narrowed, despite the relatively tight spreads.

The Asia credit sector remains supported by shorter duration, robust local funding markets and strong corporate fundamentals. Investors can capitalize on relative value opportunities and careful security selection to enhance returns. In conclusion, the robust growth profile, subdued inflation and diverse market mix of Asia make it an attractive strategic allocation rather than a tactical one.

The region's resilience, supply chain realignment and AI adoption are opening up new opportunities in the corporate bond market that were previously dominated by equity investors. Within an Asia allocation, HKD bonds serve as a defensive, high-rated local-currency holding for investors with HK dollar liabilities, and a means for US dollar-based investors to gain exposure to the region.