Growth in Asian fixed income powered by both secular and cyclical trends
Asian fixed income markets are in the midst of a sustained period of secular expansion driven by economic development and asset growth.
In recent months that growth trend has been influenced by cyclical market forces driving Asian institutions to seek out the safety of government bonds from G7 countries. It has also stepped up the pace of development of the regions’ electronic trading infrastructure.
Trading volumes in Asian fixed income increased 13 per cent in the year ending July 2012, and over the same period fixed income assets under management by institutions in Asia (ex-Japan) grew 33 per cent, according to the results of Greenwich Associates’ most recent Asian Fixed Income Investors Study.
While the surge in institutional assets under management obviously reflects market-driven valuation increases within institutional fixed-income portfolios, it also provides a clear demonstration of the market’s long-term momentum. Three strong trends drove most of the recent increase in Asian fixed-income trading volume:
1. A 55 per cent increase in trading volume of G7 government bonds
2. A 29 per cent increase in domestic currency Asian bonds
3. The continued growth of trading volumes generated by Asia’s local banks
During a period of sometimes extreme volatility, Asian investors gravitated to G7 instruments as part of a broad flight to quality, and trading volumes in Asia have been pushed higher by investors’ increased appetite for G7 government bonds. Trading volumes in Australian government bonds also remained strong during the year as investors continued to capitalize on interest rates that remained higher than those of other developed economies, despite reductions by the Australian central bank that brought those rates to two-year lows.
The steady development of the regions’ fixed income market over the year is best exemplified by the growth of domestic currency bond markets and by the increasing relevance of local Asian banks as a source of trading activity. Trading volumes in domestic currency Asian bonds increased 29 per cent in the year.
“While investors’ heavy use of G7 government bonds and G3-denominated Asian bonds over the period actually meant that domestic currency bonds declined as a share of total market volume, the trend across the region is clear: local currency bonds are emerging as a viable source of funding for issuers and as a critical component of the Asian fixed income market,” says Greenwich Associates consultant Abhi Shroff.
The slow but steady growth of local Asian banks as a source of fixed-income trading volume reflects the region’s secular growth. Domestic banks accounted for 44 per cent of overall fixed-income trading volume in 2011–2012, up from just 38 per cent the prior year.
“Across Asia, economic growth is fuelling asset growth, and we expect fixed-income trading volumes to continue climbing in the years ahead as the institutional and retail investor bases continue to expand,” says Abhi Shroff.
As Asian institutions increased the pace of trading activity in G7 government bonds in 2012, they also ramped up the share of this business executed through electronic systems. In the year ending July 2012, electronic trading platforms captured 41 per cent of G7 government bond trading volume generated by Asian institutions, up from just 29 per cent the prior year. The hefty year-to-year jump was driven by two trends: 1) more institutions are trading electronically; and 2) institutions that trade electronically are routing more trades through electronic systems.
Fixed income dealers have not resisted this transition to lower-cost trade execution, and some dealers are actively encouraging the move for some institutional clients. Several major fixed income dealers that have invested heavily to upgrade their electronic trading platforms are competing aggressively for trading volumes.
“Meanwhile, global banks are adopting new and more conservative strategies due to stricter capital reserve requirements,” says Greenwich Associates consultant James Borger. “As a result, they are narrowing their focus to a limited number of large and potentially lucrative institutional fixed income clients in Asia. Electronic platforms provide a cost-effective means of covering the rest of the market.”
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