HONG KONG: Emerging-Asia investors are betting lower-yielding bonds are set to outperform – and with good reason.

       A Bloomberg study of two of the region’s lowest-yielding markets – South Korea and Thailand – and two of the highest – Indonesia and India – reveal the former lured in vastly more funds last quarter, and they also offered wider spreads over US Treasuries compared with their historical averages.

       The preference appears to make sense given that the Federal Reserve has flagged it is on the road toward cutting back on bond purchases in coming months, a move that threatens to have a greater negative impact on riskier, higher-yielding debt in places such as India and Indonesia.

       Emerging Asia’s favourite in the second quarter was South Korea, which saw net inflows climb to a record US$33bil (RM137.07bil), boosting this year’s total to US$62bil (RM257.53bil).

       Thailand attracted more than US$2.4bil (RM9.97bil), the most since the third quarter of 2018. Indonesia saw net inflows of US$2.5bil (RM10.38bil), while India was hit by outflows of US$1.1bil (RM4.57bil).

       The ranking of inflows closely corresponds with the level of spreads versus their historical averages. South Korea’s 10-year bonds offer a yield premium of 62 basis points over similar-maturity Treasuries, an amount that equates with a z score – or number of standard deviations from the five-year average – of 1.3. Thailand’s debt, with a yield premium of 29 basis points, has a z score of 0.53.

       At the other end of the spectrum, Indonesia’s 10-year debt offers a spread of 512 basis points over US yields but that is 0.10 standard deviations lower than the five-year average. India’s 10-year yield premium is 458 basis points, but the z score is minus 0.6.

       South Korea’s three-year yields jumped by 21 basis points in June alone as traders moved to price in a quicker pace of interest-rate hikes due to accelerating economic growth and inflation. Dollar-based investors who buy South Korea’s three-year bonds and hedge via cross-currency swaps can earn a pick-up of around 90 basis points over similar-maturity Treasuries.

       “There is definitely a merit in investing in Korean bonds versus Treasuries, now that the yield gap between the two has widened even more within a short period, ” said Lee Mi Seon, an analyst at Hana Financial Investment Co in Seoul. “Inflows are expected to continue for the time being as US short-term yields are likely to stay low at least until the Fed starts to raise interest rates too.”

       While a number of emerging-Asian yield differentials look attractive, countries in South and South-East Asia in particular may need to make progress in combating the pandemic before global fund flows return. — Bloomberg