The different colors of Asian bonds

The final stop of my whirlwind global bond tour is Asia. The challenge is trying to talk about the entirety of the Asian bond market in 700 words or less given that the economic conditions, bond markets and investment opportunities vary widely across the region. To tackle this challenge, I will split the countries into three groups.

1. Large economies with limited bond markets

When people think about emerging investment opportunities in Asia, China and India tend to come up first. These two economies are likely to become increasingly important as the Chinese and Indian economies continue to expand, which could present many future opportunities for investors. However, the challenge is that today these bond markets are very difficult to access for foreign investors. Limitations on who can invest in local bonds, restrictions on how money is allowed to flow into and out of these countries, and the small overall size of these bond markets make investing there tricky. For comparison purposes, the U.S. bond market is over $19 trillion in size, as opposed to just $282 billion for China and for an Indian market that has not yet developed enough to be included in the Barclays indexes (source: Barclays Multiverse Index as of 7/29/16). Because of these reasons, neither country is included in most major global bond indexes. There may be fixed income opportunities in these markets down the road, but for now they are very limited.

2. Negative yields

Japan is the largest accessible bond market in Asia (source: Barclays Multiverse Index as of 7/29/16), but the problem is the yields for many local bonds are negative . The Bank of Japan (BOJ), in an aggressive quantitative easing campaign, has not only set short-term interest rates at -0.10% but also has bought back bonds to drive prices up and yields down. As a result, yields on government bonds with maturities of 10 years or less are negative, according to Bloomberg data. Japan does not present much of a yield opportunity right now.

3. Everyone else

The balance of countries in Asia present more interesting opportunities. To better focus our discussion, I’ll concentrate on investment grade markets. As shown in the chart below, government bond yields in Australia, Singapore, Hong Kong, Korea and Thailand are positive (source: Bloomberg as of 8/29/16). But even among these positive yielding markets, interest rates on government bonds there are low.

And, the local corporate bond markets in these countries are not very well developed, which means, unlike in the United States, there are not many opportunities outside of government securities.

Matt looks for yield in the Gangnam district of Seoul, Korea.

No perfect answer

What does all this tell us? First off, there just aren’t as many opportunities for U.S. investors in international developed bond markets. As we saw in Canada and Europe , yields are low globally. If you want to seek yield, here are two potential choices.

1. Consider longer maturity, more interest rate sensitive bonds. But the amount of extra yield you pick up for extending maturity may not be that great.
2. You can go down in credit quality, either by buying lower quality bonds in developed markets, or by moving into emerging market debt. Both options involve taking on increased default risk, and even some of these segments are getting crowded.

Bottom line: You historically can’t get a high level of yield from relatively safe fixed income investments.

Another key conclusion is that, even though many investors stateside are starved for yield and U.S. yields are very low by historical standards, they are plump relative to the global bond market. U.S. sovereign bonds yielding about 1.5% and investment grade corporate bonds yielding about 2.75% look very attractive to many foreign investors (source: Bloomberg as of 8/29/16). In a recent research report, Wells Fargo noted that foreign investors are a very fast-growing investor segment of the U.S. market, and that foreign investors now own 40% of all U.S. corporate bonds. This trend is unlikely to shift in the near term, unless we see significant changes in the way that the BOJ and the European Central Bank (ECB) conduct monetary policy. And if things keep going the way they have, you may come to think back nostalgically on the days when you could earn even 1.5% in yield.

Matt Tucker , CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog .