by Jeff Reeves | August 7, 2012 12:14 pm
There’s a lot of talk about yield these days. So if I told you I have an investment that delivers a 5% annual yield and a monthly payment cycle that has been rock-steady back to 2002 … would you be interested?
And what if I told you that despite focusing on highly rated bonds, this investment has outperformed the broader market, with superior five-year and 10-year returns, even without those dividends?
If you are, look no further than the Aberdeen Asia-Pacific Income Fund (NYSE:FAX). This closed-end fund focuses on debt securities in Asia, keeping a third of its portfolio focused on AAA-rated bonds in the region but taking a few riskier but high-yield positions to boost payouts.
It has been a profitable venture, with the fund worth over $2 billion at current asset valuations. Recent performance includes a 266% 10-year return including distributions and an 83.1% 5-year return including distributions. That destroys the S&P 500, but tops even bond kings like Bill Gross and the returns of his flagship PIMCO Total Return Fund (MUTF:PTTRX) in the same windows.
I recently had a back-and-forth with Adam McCabe, senior portfolio manager for Aberdeen Asset Management Asia (pictured), to talk about the key to his success and the outlook for the Asia Pacific region in the next several months. McCabe joined Aberdeen in 2009 from Credit Suisse (NYSE:CS), where he focused on Asian currency and interest rates along with Australian fixed-income investments. Aside from his professional experience in the region, McCabe also has degrees from the University of Sydney and the Chinese University of Hong Kong, and thus real-world experience in these regions.
Here’s what he had to say about China, Australia and the potential of targeted investments in Asian debt securities right now:
Q: China’s growth rate forecast made a lot of headlines in the last few weeks. There’s a complicated mix of causes, but what are the biggest issues in your opinion?
A: Miserable fiscal and macro conditions in Europe and the U.S. have eroded demand for exports and in turn hurt China’s GDP growth. The current slowdown is also a result of Beijing’s efforts to contain inflation and property bubbles, after massive pump-priming in 2009 led to rampant credit growth and excessive speculation in the housing market. That has led to a significant drop in property investments as well as other related sectors, such as construction.
At the same time, China has focused on rebalancing the economy away from exports, although it is evident over the short term that domestic demand has yet to completely take up the economic slack. There are signs that Beijing is worried about the slowdown and its impact on job creation. Since May, the central bank has cut interest rates twice.
Premier Wen recently indicated that more priority will be given to stabilizing growth by promoting investment. Should economic conditions continue to worsen, China has the wherewithal to bolster growth, given its $3.2 trillion in foreign exchange reserves.
Q: China isn’t the only nation FAX focuses on. Your fund info states that a minimum of 20% of total assets will be in Australia debt securities. Why the focus on Australia?
A: The fund now holds about 45% in Australian debt securities and has indeed held a large allocation to the Australian market for quite some time. Australia’s solid AAA sovereign rating, relatively liquid bond markets, sound public sector position and relatively high yields have served the fund well over the medium to longer term. We find that a core allocation to the Australian fixed-income market diversifies the fund’s holdings and supports the primary goal of distributing regular income.
Australia is also uniquely positioned to benefit from the longer-term growth trends across Asia, not only in the resources sector but also in other sectors such as services and tourism.
Q: What would be a few other regions in the Asia-Pacific that are most attractive to you right now and comprise a decent chunk of the FAX portfolio?
A: We favor local currency bonds in Indonesia, Korea, Malaysia, Thailand and the Philippines. Domestic demand, complemented by government investment programs, provides some buffer against global headwinds. We’ve also been encouraged by other positive developments.
Foreign direct investment in Indonesia has continued to grow, up 30% in the second quarter, reflecting its attractiveness to overseas companies. Korea is one of the more liquid and more developed bond markets in Asia, underpinned by fiscal stability. Malaysia, meanwhile, is boosting investments and giving a new lease of life to its capital markets by liberalizing rules, while the Thai economy is recovering much faster than expected from last year’s devastating floods. The Philippines’ efforts to battle corruption and improve efficiency have been rewarded with a series of credit rating upgrades, with investment-grade status likely in the not-so-distant future.
Q: Sovereign debt is a huge deal in the Western world right now. Has that caused any trouble for sovereign debt issues in the Asia-Pacific — either in the big players like China or the smaller ones like Malaysia?
A: Western governments have chronically high levels of outstanding public debt, whereas most of their Asian counterparts are fundamentally robust, having learned their lessons from the 1997-1998 financial crisis. Fiscal woes in Europe and the U.S. have had two main effects on financial markets so far this year: first, a broad swing from riskier assets such as commodities and equities into safe havens like bonds; and second, an influx of capital into Asian sovereign bonds, given their appeal both in terms of yield and the fiscal strength of Asian governments vis-à-vis the West.
Notably, funds focused on Asian emerging-market bonds attracted $14.4 billion in the first quarter of 2012, compared with $1.9 billion in the same period a year ago, according to U.S. research company EPFR Global.
Q: If the last few years have taught us anything, it’s how connected the global economy really is. So give me a global economic forecast for the next 12 to 18 months: Better times ahead in 2013, or worse times ahead?
A: It is difficult to see any sustained global recovery in the near term. There is no easy fix to Europe’s debt crisis, which remains the biggest risk. Bond yields are reflecting deep concerns over a eurozone exit for Greece and a bailout for Spain. Elsewhere, a moribund labor market has hindered consumer spending in the US. Even resilient Asia is starting to falter.
With these overhanging risks, sentiment could deteriorate in the months ahead if growth data and/or policy actions further disappoint.
Q: The BRICs were all the rage a few years ago, but now all of these emerging markets have their own troubles. Broadly speaking, why should investors still believe in the idea of investing in emerging markets right now?
A: Growth in emerging economies has slowed in tandem with a deteriorating global outlook. Nonetheless, it is still the world’s fastest-growing region, with the IMF forecasting 5.6% growth this year, compared to only 1.4% for advanced economies. While external headwinds, such as the European crisis and the anemic U.S. recovery pose significant risks, the underpinnings of economic growth in emerging markets are still solid.
Private-sector credit growth remains robust in emerging markets, in contrast to developed economies. Fiscal and public debt positions, likewise, are much healthier compared to the West. Emerging market companies are more profitable and have sturdier balance sheets than their developed market counterparts. In the long run, demographics also favor emerging economies — in particular the rise of a burgeoning affluent middle class.
Q: Anything else you’d like to add that we haven’t covered?
A: Our investing approach centers on three key tenets to generate our returns. First, we are long-term fundamental investors, not short-term traders. So we focus on economic fundamentals over the longer term and ignore short-term market noise. Second, we believe in diversification as a key way of generating superior risk-adjusted returns. And finally, we believe that risk management is core to our approach to managing bond funds.
For more on the Aberdeen Asia-Pacific Income Fund, visit www.aberdeenfax.com/.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing he did not own a position in any of the stocks named here.
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