Overview
Key takeaways:
- The markets of Asia's local currency government bonds have seen a fast expansion over the past two decades, making the securities an appealing diversification play at a time of increased stress for traditional safe havens.
- The bonds show low to moderate correlations with major global peers
- While the shifts in global trade are already hitting Asian economies, there are compelling arguments for both their near and long-term outlooks to support the asset class
If there is one benefit from April’s violent market swings provoked by US trade policy, it is to remind investors of the golden rule about eggs: don’t put them all in one basket.
US Treasuries have long been a comforting and fundamental ingredient to investment portfolios. Backed by the world’s largest economy, its dominant reserve currency, and a reliable institutional framework, they’re seen as a safe haven in times of uncertainty.
The changes the new administration has wrought in its first months in office have shaken that confidence, at least for foreign-based investors. The natural conclusion is that diversification matters more than ever. Luckily for investors, thanks to the broadening of global bond markets over the past two decades, there are more options than in the past.
For instance, eastern Europe’s new EU members have constructed solid, dependable government bond markets anchored by growing domestic pension fund savings.
Likewise, Asia’s local currency bond markets are far deeper than they once were, driven by growing economies and an increased appetite for domestic debt markets. The value of outstanding bonds in emerging east Asia increased from $866 billion in 2000 to $23.2 trillion by the end of 2022.[1] More index providers have added the region’s local currency bonds to their global indices, enhancing the appeal of the asset class. Ongoing market reforms have led to an increase in foreign participation.
Most notably, Asia’s local currency government bonds have low or moderate correlations with major global peers, making it an attractive tool for diversification. For example, their correlation ratios with US Treasuries and German government bonds were 0.4 and 0.3 respectively over the past decade.
Past performance is no indicator of future returns, of course, but history suggests a long-term allocation to Asia’s investment grade local currency government bonds can deliver a better risk-adjusted return to Treasuries.
If a US dollar-based investor had allocated to nine emerging Asian investment grade sovereign issuers’ local-currency bonds[2] over the 10 years to March 2025 (so not including the most recent bout of volatility), the hypothetical portfolio would have delivered a 28.2 per cent total return, higher than the 14.5 per cent for a Treasuries portfolio. The Asian portfolio would have exhibited a slightly higher volatility, but its Sharpe ratio outperformed that of the US strategy (0.6 compared to 0.4) as the larger return, largely due to Asian bonds’ higher carry, better compensated for the risk taken. It’s a similar story for a yen-based or euro-based investor over the 10-year period, as can be seen in the charts below.
It’s true that the rejigging of the global trade order has already hit Asia hard and is likely to cause further disruption in the months and years to come. Even if there is a pullback on some tariffs, Asia’s exports still face a slowdown. But the region’s economies have been here before and proven resilient: the global pandemic or the previous round of US tariffs in 2018, for example. And its governments continue to show a commitment to growth.
The near-term outlook for these markets looks compelling too. Central banks across Asia are expected to step up support. While inflation remains sticky in the US, it is cooling in most of Asia, which gives policymakers plenty of room to ease. China, India, the Philippines, and Thailand have slashed interest rates since the tariffs kicked in last month, while other countries have flagged the potential for similar moves. The rate cuts are likely to lead to some capital gains for investors over the short to medium-term, helping mitigate concerns about global trade frictions.
Whatever the outcome on tariffs, the region will remain an important driver of global growth over the long term. Fiscal plans, as well as monetary support, are likely to limit the downward pressure of tariffs on economies. And as Asian countries look inward toward domestic demand as a new growth engine, their vast populations and youthful demographics will support the structural shift.
Of course, in the short term, investors should watch the rapidly evolving trade landscape carefully and continue to monitor how Asia absorbs any shocks it delivers. From a market reform perspective, local bond markets also need to do more to strengthen infrastructure, improve liquidity, and enhance transparency.
But for investors worried about the US’s growing debt burden and the uncertainty about tariff policy, local currency government bonds in Asia, where the policy outlook appears clearer, may be a more appealing diversification play than they were at the start of the year.
[2] The hypothetical portfolio is equally weighted in the nine emerging Asian markets.
