Gabriel Yu, portfolio manager at Ping An of China Asset Management (Hong Kong), explains the process behind his fund's award-winning performance last year.

Environmental Finance (EF): Can you describe your investment process?

Gabriel Yu (GY): Our process is rooted in finding value dislocations. This includes relative value analysis as well as fundamental analysis. We have regular meetings and aim to identify any significant spread opportunities. We will compare spreads with other issuers and historically to see if they are trading at attractive levels. For example, suppose we see an improvement in the credit situation. In that case, we will put that into our financial model and determine whether the implied rate of interest is going to go up or down, which will tell us if current spreads are justified.

Primary markets have been a big supplier of alpha for green bonds. In Asia, we don't see a considerable greenium at this point. Green bonds are issued at pretty much the same level as conventional bonds in the primary market for strong issuers. For most, when they go to the secondary market, spreads tighten very quickly, so the greenium narrows. Also, supply is held very tight. There is not much supply for people who buy green bonds, so they tend to hold on to them long-term, even when markets are very volatile.

We consider the Climate Bonds Initiative taxonomy when choosing green bonds for our portfolio. We will look at the best sectors in Asia, typically transportation, renewable energy and green buildings. We also look at track records, whether these issuers have recently issued bonds and how their corporate governance standards have been in the past. Regular disclosures are also essential because if they don't disclose at least semi-annually, it can be tough for us to track environmental data and form a clear opinion. Finally, we consider whether an issuer has a second-party data provider, which also helps us refine some of the data and the framework and assures us that their process is more standardised with international standards.

EF: What drove performance in 2023?

GY: Last year's main driver of performance was the rates market. It was a particularly volatile year for rates, starting in January at around 3.5% before rallying to 5.3% at its highest. The problem is that this creates more yield, and from a fixed income investor point of view, you can lose out a lot.

We made 5.5% in 2023 because we pre-emptively took a defensive stance. We expected the market to become more volatile in anticipation of a rate-hiking cycle. During rate-hiking cycles, you have a very big downside risk, so we chose to position our fund with less duration. That helped our portfolio a lot. Towards the end of the year, we increased duration when rates started to come down a bit, and markets were pricing in a softer stance on inflation by the Federal Reserve.

Our defensive stance during 2023 meant we reduced some of our exposure to Chinese Mainland and Hong Kong. Although the technicals were still very strong for Hong Kong bonds, there was not a lot supply from Chinese Mainland, bonds were tightly held by investors, and yields didn't blowout too much. So, we decided to trim some exposure in case of some potential headline risk that could affect all the bonds we were holding.

We redeployed some of that cash elsewhere in the region, adding more exposure to Japan, South Korea, and India. We also added some high-yield exposure for carry because of concerns about rate volatility, which protected the portfolio from long-end yield movement.

EF: How is the fund positioned currently?

GY: We haven't added much more duration since last year. One of the issues for us is that spreads are pretty tight at the long end right now, but we will look to extend the portfolio's duration in the coming months gradually. New issuance in Chinese Mainland and Hong Kong remains very limited, so we haven't been able to add to new or existing positions. We are looking for opportunities to move out of our sovereign or quasi-sovereign bonds where spreads have become too tight. We want to add more to India, which currently represents around 10.5% of the portfolio. And we might shift out of some Japanese and Korean names, which have tightened somewhat. But we are not looking to deviate too much from last year in terms of duration or regional exposure.

We have added some high-yield exposure because we are unlikely to get much contribution from higher interest rates. We've already moved from 5.2% to 4.2%, which is a 100 basis point move.

EF: What will be the biggest challenges or opportunities over the next 12 months?

GY: Despite the issuance slowdown, we still believe there is a huge opportunity with China for several reasons. In April, during the National People's Congress, one of the things mentioned was the new three pillars of economic development – industries that will drive growth in China. These included electric vehicles, energy storage, and solar panels, among others. China has been a big manufacturer and exporter of these products, and it suggests that China is very focused on furthering green development. The economy has been on a slowing trajectory because of the collapse of the Chinese property sector, but we believe that growth in sustainable industries can help fill some of that gap. And that will be positive for the green bond market.