Rising geopolitical risks and ultra-low global interest rates are prompting a flight to quality among bond buyers according to a survey of Asia-based investors conducted by FinanceAsia and National Australia Bank (NAB) for the annual Australia Report.
Australia continues to provide a safe haven for fixed-income investors from the region, but the focus has shifted away from lower-rated corporates to government and supranational bonds.
In the latest survey of institutional investor appetite for Australian and New Zealand debt securities, Asian bond buyers were asked to provide information on their allocation strategies and indicate whether they planned to increase or decrease their exposures. Similar polls have been conducted by FinanceAsia and NAB every year since 2013.
Some 65 investors representing all types of firms participated in this year’s survey, although a larger proportion of asset managers and pension funds took part and fewer hedge funds participated. Geographically, the respondents were spread more evenly between countries than in previous years with 20% indicating they were based in Hong Kong, 26% in Singapore, 18% in Korea, 11% in the Philippines and 6.1% in Malaysia.
The deepening of the market’s appeal was evident in the number of investors in this year’s poll who reported increasing their Australian dollar bond holdings over the past 12 months. A full 64% of those surveyed said they had increased allocations during the year, with 9% stating allocations were significantly higher.
More than 27% of respondents now have 3-5% of their portfolio dedicated to Australian dollar debt securities compared to 23% in 2015 and 17% in 2014. Meanwhile, those with a 1-2% allocation now make up 36% of all investors polled compared to 27% in 2015 and 15% in 2014.
“The steady upward trend in allocations is a real sign that the market is on a steady growth trajectory,” said Connie Sokaris, head of investment grade originations at NAB.
Prudent times
One of the most consistent trends in the survey demonstrated was a preference for higher-rated credits.
“The survey results reflect what we hear from investors on the ground, and that is a general shift towards a more conservative approach,” said Jessica Tilton, head of markets for NAB in Asia. “Investors are less sensitive to price and sector dynamics, and more focused on credit ratings. There is also a focus on yield – which might sound counterintuitive given the emphasis on higher ratings – but I think this just shows that Australia still offers the best yields in the developed world for a AAA-rated country.”
The flight to quality was clear in the survey. Last year investors said they were focused on yield and secondary liquidity, with 68% and 70% of respondents respectively saying these were essential factors when analysing a bond. Credit ratings were ranked as essential by only half of those polled in 2015. This year, however, 68% ranked credit ratings as essential, and 77% said yield was central to their decision-making process.
“This switch in focus started to occur at the beginning of 2016 and gathered pace after the Brexit vote,” said Sokaris. “There is a general level of caution in the market due to the emergence of new geopolitical risks and concerns about the slow pace of economic growth around the globe. Everyone is looking for a safe haven where rates are still high enough to offer a reasonable return, and that’s why Australia consistently comes up as a good investment option.”
She said Australia has attracted even more attention as onshore rates in markets like Japan and Korea have fallen.
While previous surveys have charted a growing appetite for high-yielding non-rated or investment-grade corporate bonds, this year’s poll shows a preference for highly-rated government bonds. Asked which issuer type they would like to see come to market, investors pointed to supranationals (with 19% wanting more of these bonds this year compared to 10% last year), semi-governments (12% compared to 8%) and covered bond issuers (12% compared to 2%).
There was also a drop in appetite for financial institutions, indicating investors may be reaching exposure limits on some of these credits. This year only 9% of respondents said they would like to see more issuance from banks compared to 20% last year and 33% in 2014.
Furthermore, senior debt is preferred over subordinated issuance. “This is likely to be driven by a focus on credit quality but also points to the uncertain regulatory environment,” said Sokaris, interpreting why only 18% of participants said they would like to see more subordinated debt from bank issuers. “The market is waiting on some clarity around how senior and subordinated debt will be treated under new banking rules. Investors are still evaluating the risks in the unsecured portion of their portfolios and the poll results show they aren’t so focused on the sub-debt piece.”
On the topic of industry preferences, survey participants listed infrastructure (24%) and utilities (19%) as favourites in this year’s poll. “These sectors have always been popular and Australia has an enviable pipeline of new infrastructure projects ready to go,” said Sokaris. “With a flight to quality under way, regulated assets with strong cash flows will become even more attractive.”
