investment viewpoints
Asian credit: a source of efficiency in credit allocation
In this third article of a series drawn from our latest research paper, we make the case for Asian investment grade (IG) credit1 as a means to make a core credit allocation more efficient. Previous papers have explored the structural factors driving the asset class’s growth, and the diversification benefits it offers. Look out for the final article of our series, which will look at the future of this asset class and offer an overview of key indices and benchmarks.
| Need to know: • The Asian IG credit market, measured by the JP Morgan JACI IG index, has historically outperformed the global IG credit market, represented by the Bloomberg Barclays Global Aggregate Index. Hard currency Asian credit also benefits from no exposure to currency volatility. |
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Asian vs global IG credit: which one has historically outperformed?2
Looking at long-term returns, Asian IG credit has displayed an attractive total return profile compared to a traditional global aggregate strategy. In figure 1 below, the Asian IG market is represented by the JP Morgan JACI IG index, which has outperformed the Bloomberg Barclays Global Aggregate Index on a hedged and unhedged basis since the JACI index’s inception in 2005.
FIG. 1. Comparative performance of Asian credit (JACI) against Global Aggregate (hedged and unhedged) since 2005
Source: LOIM, Bloomberg indices, JP Morgan indices. As at April 2022. Past performance is not an indicator of future returns.
The Asian IG credit universe represented in figure 1 is a hard-currency market, consisting of US-dollar denominated bonds only. By comparison, in the Global Aggregate universe, about 89% of issuance is denominated in major developed-market currencies (including USD, EUR, JPY, GBP etc). In addition, about 11% of issuance is in the form of emerging-market local currencies across various denominations. This can introduce currency risk and increase volatility, as well as driving up hedging costs for currency-hedged investors. In contrast, investors in Asian IG credit are not exposed to currency volatility, which creates a clear benefit from an overall portfolio perspective.
The role of Asian IG credit within a wider global credit allocation
Before considering Asian IG credit’s potential role in a wider portfolio, it is important to note that global bond yields are currently at significantly lower levels than in the past. Only limited conclusions and inferences for the future can therefore be drawn from an efficient frontier analysis based on historical values. However, an analysis of combinations of Asian credit within a wider global bond allocation, as represented by the Bloomberg Barclays Global Aggregate Index, shows that the right proportion of Asian IG credit can make a combined portfolio more efficient (see figure 2).
FIG. 2. Efficient frontier analysis of Asian IG vs Global Aggregate credit
Source: LOIM calculations. Bloomberg. As at 31 March 2022. Period of analysis: 31 Dec 2005 – 31 September 2021 using monthly values. Based on Bloomberg Barclays Global Aggregate Index USD (unhedged).
FIG. 3. Risk (standard deviation) and returns combining Asian IG and Global Aggregate credit allocations (historical performance 31st December 2005 to 30th November 2021)
| Weight JACI IG | Weight Global Agg | SD p.a. | Return p.a. | Sharpe Ratio (Ret / SD)* |
|---|---|---|---|---|
| 0% | 100% | 5.35% | 3.06% | 0.57 |
| 10% | 90% | 5.19% | 3.23% | 0.62 |
| 20% | 80% | 5.06% | 3.40% | 0.67 |
| 30% | 70% | 4.98% | 3.57% | 0.72 |
| 40% | 60% | 4.94% | 3.74% | 0.76 |
| 50% | 50% | 4.94% | 3.92% | 0.79 |
| 60% | 40% | 4.98% | 4.09% | 0.82 |
| 70% | 30% | 5.07% | 4.26% | 0.84 |
| 80% | 20% | 5.20% | 4.43% | 0.85 |
| 90% | 10% | 5.36% | 4.60% | 0.86 |
| 100% | 0% | 5.56% | 4.77% | 0.86 |
Source: LOIM calculations. Bloomberg. 31 September 2021. Period of analysis: 31 December 2005 – 30 September 2021 using monthly values. *Assume zero return for cash. For illustrative purposes only.
Specifically, a simple historical efficient frontier analysis suggests that the most efficient combination from a risk/return perspective would be an approximate 50/50 split. Given the relatively lower yield and longer duration of the Bloomberg Barclays Global Aggregate Index versus Asian IG credit, the buffer for higher interest-rate volatility for the latter is much lower.
We therefore believe that in the future, an ‘efficient’ allocation to global credit would actually need to include a larger component of Asian IG credit – as suggested by this efficient frontier analysis.
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Sources
[2] Global IG credit universe approximated using the Bloomberg Barclays Global Aggregate index. Past performance is not an indicator of future returns.
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