Asian Debt Hit on Two Sides; Money Managers Pull Back in Face of Weakening Currencies, Rising Bond Yields

June 7, 2013, 6:32 p.m. ET

Asian Debt Hit on Two Sides

Money Managers Pull Back in Face of Weakening Currencies, Rising Bond Yields

By FIONA LAW

HONG KONG—The $2.76 trillion market for Asian local-currency debt is reeling from weakening currencies in the region and rising bond yields around the world.

The HSBC HSBA.LN +1.14% Asian Local Bond Index, which measures the performance of local-currency bonds in some Asian countries but excludes Japan, has fallen 3% from May 9 through Thursday, a selloff that has pushed it into negative territory for the year.Until recently, the market for corporate and government bonds denominated in currencies such as the Philippine peso and the Indonesian rupiah has been a global hot spot for fund managers looking for returns above those offered by Western government bonds. In 2012, bonds in the index returned 8.9%, with both capital appreciation and interest payments taken into account.

But amid rising expectations that the U.S. Federal Reserve will soon dial back its stimulus, Treasury yields have risen and the dollar has strengthened—markedly against emerging-market currencies—in the past month. Seeing the dual threat to their portfolios, many managers are taking these signals as a cue to sell local-currency debt. Bond prices move in the opposite direction of yields, and when Treasury yields rise, interest rates on bonds of all stripes usually follow.

The situation “is a reversal from last year, when we could be one-way buyers of Asian currency assets across the board,” says Arthur Lau, head of fixed income in Asia excluding Japan at PineBridge Investments, which has $71.5 billion in assets under management. Mr. Lau says he has cut back on local-currency bond holdings this year.

Corporate borrowers are switching to the dollar-bond market, lured by cheaper costs because interest rates there remain historically low despite the recent uptick in yields.

Issuance in domestic currencies in Asia is down 13% so far this year to the equivalent of $94.45 billion, when compared with the same period in 2012, according to data provider Dealogic. This figure excludes China’s domestic bond market, which is mostly closed to foreign investors.

Wheelock 0020.HK 0.00% & Co., an investment- and property-holding firm in Hong Kong, last year raised 300 million Hong Kong dollars (US$39 million) in five-year debt, currently yielding 3.59%. In March, the company chose to skip the local-currency debt market and issued $500 million, also for five years, in dollar bonds, which carry a 3.48% yield at the moment.

In 2012, issuance of Asian local-currency bonds rose 16%, to a record $273.8 billion, according to Dealogic.

Some fund managers, though, point out that interest payments offered by Asian local-currency bonds remain broadly higher than on comparable bonds in the U.S. and Europe. And despite the recent concerns about Fed tapering and the global economy that have driven the Malaysian ringgit to two-month lows and the Indian rupee to 11-month lows, many say Asia’s growth potential would once again lure investment funds, which in turn would once again spark currency appreciation.

“From a long-term perspective, I remain positive on local-currency bonds, and expect them to perform well and to continue to attract inflows,” said Stephen Chang, head of Asian Fixed Income in Hong Kong at J.P. Morgan Asset Management, which oversees $1.4 trillion. Still, he is hedging his foreign-exchange exposure to local bonds to minimize currency risk in his portfolio.

One bright spot, too, has been offshore yuan bonds, known as the dim-sum bond market. The Chinese yuan is one of the few Asian currencies to strengthen this year, up 1.5% as China’s central bank has guided it higher against the dollar.

Still, many investors are becoming more attuned to the risks of weakening currencies, especially as central banks take steps such as cutting benchmark interest rates to protect the competitiveness of exporting industries.

Last week, Thailand’s central bank said it was ready to implement capital controls to cool the baht further. It now is trading flat for the year, down from a 16-year high in April.

“There has always been a lingering concern about possible capital controls,” said David Tan, chief investment officer for fixed income at Allianz Global Investors, which has $411 billion under management. Mr. Tan has been switching into cash and selling bonds denominated in the baht and Malaysian ringgit.