The global economic context reinforces the argument for the Indian bond market. India’s transformation is mainly an internal growth story, in contrast with that of China, for example. India’s economy has a low correlation with international markets, and this extends to Asia.
A study conducted by Bank of America Merrill Lynch found that the average correlation of Indian bonds with the rest of Asia has been close to zero over the last 5 years. Indian bonds, therefore, offer a large source of diversification for investors in international debt.
Due to all of the above, Aberdeen is still quite bullish on India and if we ask its managers and analysts what their high conviction ideas are for the coming months, Kenneth Akintewe, Senior Investment Manager for the firm’s Asian fixed income team, is convinced that, almost unanimously, the answer would be precisely that one. Not surprisingly, the firm has positions in the country’s fixed income and equity products.
Its bond fund, launched in 2015, has been very well received in the US offshore market and in Latin America and already exceeds 200 million dollars, in assets under management. India’s bond market is a large and liquid market, with over one trillion in debt, and with an attractive return of 7.42% so far this year. The average duration of the Aberdeen strategy is 6.4 years and it has an investment grade rating of Baa3. Currently, there are only about five funds in the market competing within this asset class.
“Presently, India’s story is one of exceptional growth and reform, but that is not the only reason. There’s many. A key factor is that, if we think about the current global environment, there are multiple risks such as global policy, global demand, commodity market performance, geopolitics, as well as high correlations between most core markets, and we have very few options that help counteract these risks. Indian debt, however, is an asset class with low correlation with other markets,” explains Akintewe.
The Indian bond market is a large, liquid market – over a trillion dollars – and Aberdeen has been investing there for about 10 years. They consider this an achievement when taking into account that, until a few years ago, India had the dubious honour of being part of the group of economies known as the ‘Fragile Five’, i.e. the five emerging economies which were very dependent on foreign investment in order to finance their growth, with high levels of fiscal deficit, current account deficits and a high degree of institutional corruption. Access to capital markets was very difficult for them.
But Akintewe explains the transformation: “Ten years ago, the context for bond investment was radically different. Capital market regulations made it very difficult to invest. International investors required a licence first, then they had to have a quota for government bonds and another one for corporate debt, which were subjected to multiple layers of other rules and restrictions. If you sold one of the positions you lost your quota and would have to wait for an undeterminable amount of time to get another one, meaning active management was impossible”, he recalls.
The reform of the capital markets, however, has been greatly simplified, and for Aberdeen that means that it now makes sense to market a fund of these characteristics. “Now we can actively manage risk,” the manager points out. But despite this opening, the exposure of foreign investors to the country is still small. This is partly due to the fact that, due to capital controls, India is not part of most bond indices, not even that of the emerging markets. Aberdeen examined about 160 emerging market local currency bond funds and found that the average exposure to India was less than 1%, a ridiculously small amount considering it has not only been one of the strongest reform stories in EM but one of the most consistently best performing trades over the last few years.
The main players in the domestic bond market are essentially institutional investors or Indian insurers, although Akintewe believes that as the market grows international investors will pay more attention to it. There are currently one trillion dollars in the Indian bond market, with $700 billion corresponding to the public debt market and $300 billion to the corporate debt market. The share of the government bond market that foreign asset management firms can access was 3.5% in 2015 but is being increased to 5% by March 2018. The market has seen increasing participation but, Aberdeen’s manager explains that for the overall bond market foreign exposure is still low at around 7.5%. . In other EM bond markets foreign exposure can be 30% or much higher in some cases, making them vulnerable to changes in investor sentiment.
“There is still room for growth. Progress is very gradual, but it is expected that in the long run the government will be more comfortable with international investors in its bond market. Therefore it is possible that the foreign quotas could be increased, particularly with respect to the 51 billion dollar corporate bond quota, as it is in the country’s interest that companies continue to have uninterrupted access to capital.
Regarding the risk profile of the Aberdeen funds, the manager explains that it is an asset class with little correlation to issues that are very correlated with other emerging markets, such as oil, even with the global bond market, or with emerging debt. It is a market that is linked more to internal factors such as monetary, fiscal, deficit reduction or inflation control.
“Local insurers are increasing their assets by 20% annually thanks to the population’s wealth growth, so technically there is a very strong growth in demand from the local institutional sector. And it is a very liquid market particularly compared to other emerging markets with government, quasi-government and the more highly rated corporate issues trading with tight bid/offer spreads of 2-3bps and in large sizes.
The Aberdeen Global Indian Bond fund invests in local currency bonds. Akintewe explains that it is the most uncorrelated asset, because including Indian debt in hard currency in the portfolio means there is a certain correlation with US Treasuries.
Akintewe knows that the currency risk exists, it’s clear. “However India remains committed to fiscal reform, has built a high level of foreign exchange reserves, has seen its current account deficit come down significantly and moved to a positive basic balance of payments position thanks to very strong growth in foreign direct investment meaning that the rupee enjoys firm support from its underlying fundamentals., We estimate that the Rupee will be able to stay at current levels or even appreciate around 1% to 2% against the dollar, but the key is its low volatility which is half to a third of other G10 and EM currencies.”
“We must point out that the fund’s volatility is quite low compared to other emerging market bonds, and of course, much lower than any exposure to Indian equities. Since its inception, the fund’s volatility has been at 5.6%,” he concludes.