Asia Fixed Income Needs a Bigger Map

Our Head of Asia Credit Strategy Kelvin Pang explains why investors would benefit from a broader fixed income market in Asia, with opportunities across more countries, local-currency credit and dollar-denominated bonds.

Read more insights from Morgan Stanley.

----- Transcript -----

Welcome to Thoughts on the Market. I’m Kelvin Pang, Head of Asia Credit Strategy [at] Morgan Stanley.

Today – why the challenge in Asia fixed income may not be the region at all, but the way investors have traditionally looked at it.

It’s Tuesday, October 13th at 8am in Hong Kong.

Picture this. You’re shopping in a supermarket. As you walk down the aisles, you notice half of them are off limits. It’s unexpected.

Something similar has happened in Asia fixed income. The region’s fundamentals remain supportive, but the traditional investment universe has become increasingly constrained.

The pressure began in early 2023, when U.S. policy rates rose above those in much of Asia for the first time since before the Global Financial Crisis. The environment that had supported Asian bond markets for years turned upside down.

Consider Asia-dollar credit. Issuers have increasingly turned to cheaper local-currency financing, which is shrinking dollar-bond supply. Asia-dollar credit is now on track for a fifth straight year of negative net supply. At the same time, investment-grade spreads have tightened to 55 basis points. That makes Asia investment-grade credit the most tightly valued major credit market globally.

And investors have taken notice of this. Assets in dedicated Asia credit and high-yield funds have fallen 62 percent from their 2021 peak – from roughly $75 billion USD to around $29 billion USD.

But we feel Asia itself is not the problem. In fact, Asia Pacific nominal GDP could rise from $41 trillion USD in 2025 to [$]54 trillion by 2031. That would account [for] roughly one-third of global nominal GDP growth over that period.

And most importantly investment is also accelerating. Asia’s capital spending could rise from $11 trillion to [$]16 trillion by 2030. That would mark the strongest industrial cycle since the mid-2000s. And we think this extends well beyond AI, with energy, defense, and broader industrial investment all playing major roles.

The key issue here is how investors have traditionally looked at Asia. They basically need a bigger map.

That broader map is what we call APAC fixed income. Traditional Asia fixed income has largely focused on U.S.-dollar credit and local-currency government bonds across emerging Asia. APAC fixed income adds convertible bonds and local-currency corporate credit. It also brings Japan and Australia into the mix.

So, what’s the advantage of this broader map? You see, each of these pieces behaves differently. Convertible bonds let investors participate in regional growth through their equity link. APAC dollar credit plays a more defensive role, with a mostly investment-grade, U.S.-dollar-denominated profile. Local-currency rates provide exposure to interest rates, currencies and the economic cycle. At the same time, local-currency corporate credit broadens credit and sector exposure.

Together, they create a more flexible mix of risks across changing economic conditions. For example, when growth and inflation rise together, convertible bonds can benefit from their equity link. In a recession, currency-hedged local bonds can benefit from falling rates while limiting foreign-exchange risk. During stagflation, dollar credit can offer more defensive characteristics.

Our portfolio analysis since 2023 suggests a diversified APAC fixed-income portfolio could target a 7.5 percent return with a vol[atility] of roughly 4 percent, depending on allocation constraints. Investors also increasingly need to manage currency exposure as the dollar cycle shifts.

For years, investors could navigate Asian bonds with a relatively narrow toolkit. Today’s market demands more flexibility. The opportunity in Asia has not disappeared. The better question may be whether investors are looking at enough of it.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.