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Asia Bonds Mirroring U.S. Bonds Could Lead to Global Bond Crisis

This article was originally published on ETFTrends.com.

Asia bonds appear to be mirroring the U.S. bond market with respect to concerns surrounding BBB-rated debt falling into high-yield territory, which could trigger a global bond crisis.

When risk-on sentiment was at a peak during the thick of the extended bull market, risky less-than-investment-grade bonds were in vogue with their attractive yields, particularly in a rising rate environment, but BBB bonds that are on the cusp of high yield status could be facing a liquidity crisis, according to a recent CNBC report.

As the latest bouts of volatility have been racking the stock markets, it has also affected the bond markets, particularly liquidity–the ability purchase and sell an asset within a reasonable amount of time. BBB bond markets are especially susceptible because institutional investors, who carry war chests full of capital that aid in liquidity, aren’t able to invest in these bonds if they become high yield or “junk” issues.

BBB bonds comprise almost 50% of the $5.8 trillion investment-grade bond market and a lack of liquidity could leave BBB bond investors holding the debt as it toes the line between investment grade and junk bond status–the worry, of course, being that it may eventually fall into the category of the latter.

“There’s a lot of worry about the BBB-rated world,” said Jason Shoup, head of global credit strategy at institutional asset manager Legal & General Investment Management America.. “It’s not an issue today, but in a recession, it’s possible that between $500 billion and $1 trillion in BBB-rated bonds could slide into the high-yield market.”

 Now, it appears that Asia is facing the same problem with investment-grade corporate debt down 1%, according to an article in the Wall Street Journal. Like the U.S., BBB bonds make up a good portion of investment-grade debt in Asia--44%--and they, too, are on the verge of a falling into high-yield or "junk" status. A number of investors are worried that Moody's Investors Service will take these Asia BBB bonds and knock them down a notch lower--the downgrade, of course, putting a majority of them into the less-than-investment-grade category. “People are worried about the potential turbulence” said Anne Zhang, an executive director in the fixed-income team at J.P. Morgan Private Bank in Hong Kong. “We have been telling investors to up the credit quality." U.S. Investment Grade ETF Options

In order to avoid a possible liquidity crisis, investors can opt for more liquid exchange-traded funds that allocate capital into investment-grade debt issues, such as the  iShares 1-3 Year Credit Bond ETF (CSJ) and  ProShares Investment Grade—Intr Rt Hdgd (IGHG) .

CSJ tracks the investment results of the Bloomberg Barclays U.S. 1-3 Year Credit Bond Index where 90 percent of its assets will be allocated towards a mix of investment-grade corporate debt and sovereign, supranational, local authority, and non-U.S. agency bonds that are U.S. dollar-denominated and have a remaining maturity of greater than one year and less than or equal to three years--this shorter duration is beneficial during recessionary environments.

IGHG tracks the performance of the Citi Corporate Investment Grade (Treasury Rate-Hedged) Index with long positions in investment grade corporate bonds issued by both U.S. and foreign domiciled companies. This is particularly important during market downturns when the propensity for a company to default on its debt is higher. As such, IGHG focuses on investment-grade issues to reduce credit risk.

Related: 3 ETFs to Consider as a Possible Liquidity Crisis in BBB Bonds Looms

For more trends in fixed income, visit the Fixed Income Channel.