John Woods, managing director at Citi Investment Management, looks after Asian fixed-income portfolios for Citi’s private banking clients. Based in Hong Kong, he invests in US dollar-denominated investment grade securities issued from Asia ex-Japan.
India: more than Modi?
India could be the new China, or at least will become so over the next 10 years. The election of the new prime minister has electrified the market this year. There is optimism about the economy that I haven’t seen for many years. There is now momentum and I think India will become a powerful force in Asian fixed-income over the coming decade or longer. It really has the potential to be a major contributor to the growth of the bond market, given its need for infrastructure and other financing needs. Already the market is pricing in an upgrade as the sovereign is trading at rich levels given its BBB- rating.
Could it go to single-A?
I would say it could go to BBB or BBB+ in the next three to five years. That’s a very boring call.
In other words, let’s not get carried away.
Right.
Indonesia.
Again, positive tailwinds following its election and the new president’s subsequent economic reform agenda. Indonesia has a low level of US dollar debt as a proportion of GDP, and there is likely to be more issuance over the coming years. Its sovereign and quasi-sovereign issues are trading at rich prices relative to Indonesia’s fundamentals, so again that suggests the quality is higher than its credit rating implies.
What are you not keen on right now?
Korean risk, mainly because of the valuations. The supply available is mostly short-dated and rich relative to Korea’s economic fundamentals. Issuance volume has dried up over the past five years. I’d like to see borrowers there do more, as the outstanding issuance doesn’t reflect the realities of today’s fundamentals. But Korean borrowers have preferred to focus on managing liabilities in local currencies – which has made sense for them, because they can issue longer-dated securities at good prices in the local market.
With regard to credit ratings, the Chinese government and other regional governments are keen to push local credit-rating agencies. There is a meme here that the big-three rating agencies [Fitch, Moody’s and Standard & Poor’s] not only got structured products wrong but are beholden to political interests in the West and, therefore, unfair.
And credit rating agencies in Asia wouldn’t be? Look, I’d say the more the merrier, if it helps dilute the influence of the big three. That would not be a bad thing. The Lehman crisis showed that investors must do their own research. We can’t depend on third-party agents. More contributions to that offer greater opinions, new perspectives and more information. But the cost of the infrastructure required to roll out a rating agency at a global level is quite extraordinary. Unless you have a brand, your ability to charge investors is going to be limited. Moreover, there is now a range of quantitative derivative rating agencies coming online. They can capture short-term moves in credit quality very cheaply and quickly, without the costs of an army of analysts.
Could these disrupt even the big three agencies’ businesses?
More companies are filing their accounts online. That makes it easier in theory for quant agencies to access balance sheets more quickly and cheaply, and through algorithms assign a rating. I see that business model is just around the corner. It may not have the human touch but experience suggests that, maybe, we don’t always want a human touch.
With all of this issuance are you concerned that many Asian borrowers are at risk of foreign-currency mismatches again?
Yes. The single most important risk in Asia is the 50% devaluation of the yen since 2012. A currency of that magnitude cannot experience such a level of weakening without having a regional impact. Everyone else’s relative competitiveness and terms of trade is being negatively affected. You will see pressure on the won, on the renminbi, on the baht over the coming years. That is precisely what happened when the yen devalued by 65% from 1994 to 1998. Some observers cite that period’s combination of yen weakness and dollar strength as the primary cause of the Asian financial crisis. So I am aware of the wider risk that yen weakness can mean for Asia.
Does a much bigger Chinese economy mitigate some of that yen-derived risk?
US import prices from Japan have fallen precipitously over the past year. I’m sure [the] Chinese authorities look at the same numbers as I do and are wondering if they should respond. If the region experiences a competitive round of devaluation, that would generate a deflationary wave of sizeable proportions – a wave that would hit the shores of developed markets and keep their bond yields low for some time. I’m saying Asia may be the catalyst. That is not Citi’s house view but as an individual portfolio manager, it’s my opinion.
How do you treat the lack of liquidity in secondary markets due to the withdrawal of broker-dealer market makers?
There is no reasonable way around it.
Does that mean you have become, in effect, more of a buy-and-hold investor?
Well, it’s easy to sell a bond but harder to buy one.
That’s now. In a crisis, it would be the reverse. So between fears of currency mismatches, currency devaluations and possibly difficult exits in a crisis, how do you position the portfolio today?
By identifying companies that have US dollar earnings and liabilities, with sufficient cash piles and net cash positions to weather any debt-servicing problems. I deal only in investment grade issues, which by definition have robust balance sheets. But I know from bitter experience what panic and contagion can do to markets. You can have prudential and cautious credit analysis but a crisis can envelop everything. That’s a risk – but it’s not my central thesis. My case is that soft demand means continued low yields, continued yield hunting by investors, and continued good performance for Asian fixed income.
