FUND VIEW-Indonesia, Malaysia local debt top picks -Stone Harbor

HONG KONG, Nov 2 - Appreciating currencies and moderating inflation expectations will boost Asian government domestic bonds, a fund manager with fixed income specialist Stone Harbor said on Monday.

Jim Craige, senior portfolio manager with the investment boutique which oversees $19 billion in assets, said local bonds from governments like Indonesia and Malaysia would give returns in excess of 15 percent over the next 12 months as investor perceptions about the region change.

"We are at an inflection point where local currency bonds will heavily outperform dollar bonds," he told Reuters in an interview while adding that dollar bonds would find it difficult to duplicate this year's performance.

The proportion of Asian local currency bonds in the aggregate portfolio of funds he oversees would double from the current 8 percent over the next quarter to reflect the outperformance expectations, he said.

Indonesia's 10-year dollar bonds sold in March this year at a yield of 11.75 percent have rallied sharply on the back of the surge in risk appetite and are currently yielding around 6 percent.

In contrast the 10-year rupiah-denominated government bonds are still yielding more than 10 percent, while the currency <IDR=> has appreciated about 15 percent in the year to date.

But Craige said perceptions about developing markets are changing because of better growth prospects, improved debt/GDP ratios, moderate inflation expectations and growing foreign exchange reserves.

He said the weighting of emerging market debt in pension fund portfolios, currently less than one percent, would have to increase also to reflect the higher contribution of their economies to the global aggregate.

The liquidity premium that was attached to longer dated debt from emerging market governments would also fade, he said.

"We believe a lot of yield curves are steep, because of lack of liquidity and some inherent inflation risk that is not warranted," he said, forecasting curve flattening in emerging markets.

Indonesia and Thailand both released inflation data on Monday that was benign relative to market expectations.

But Craige said his fund would be very selective about investing in Asian corporate debt due to supply concerns.

"The corporate market needs to issue in 2010; there are a lot of rollovers that need to be plugged. That is one of the reasons why we are underweight on corporates because supply overhang will be significant," he said.

Debt issuance in the region has started to pick up and there are concerns foreign currency denominated bonds are being priced at aggressive levels, he said.

Issues of bonds denominated in dollars, euros and yen have raised about $8 billion in October, compared with $47 billion raised in the first nine months of the year, averaging a shade over $5 billion each month.

"Underwriting fees are small and everyone wants to be up on the league table and so deals are being priced tightly. It is indicative of a market that is ripe for widening," he said.