Bullish on bonds
Daily markets tell a tale of unremitting gloom. Economies are weak, share prices are sinking, the euro-zone crisis goes on and on. But there is a market out there that is not just trending up, it's booming: bonds.
'Bonds are witnessing the sort of demand frenzy that we saw in the IPO market back in 2007. New issues are becoming oversubscribed multiple times, often within hours of launch,' says John Woods, chief investment strategist, Asia Pacific, Citi Private Bank.
The strong demand is translating into rising prices. The HSBC Asian High-Grade Bond Index, a benchmark, is up 7.5 per cent in the year to date. The HSBC Asian High-Yield Bond Index is up 14 per cent in the same period.
Forget about equity - a sinkhole of despair that, lately, has never failed to disappoint. These days the smart money is in bonds. The asset offers safety, often strong returns and, with issuance levels so high, there are plenty of deals to buy. There is also diversity. People can choose from a wide variety of credits, returns, structures and currencies.
Issuance levels are indeed strong. Asian bond issuers this year have already matched the total volume of last year.
Bonds are back, and this is a particularly Asian story. Asia's corporations are coming to the bond market partly because bank loans - traditionally the main source of corporate funding - are under pressure. Banks need to comply with a global standard known as Basel III that kicks in next year. It will cut the amount of capital banks can lend, and they are already trimming their loan books to comply.
Meanwhile, the euro-zone crisis is forcing European banks to pull money from Asia. The institutions need to increase their reserves to insulate them from shocks in their home market. The big European banks are traditionally big lenders in this region and their pull-back has put a major dent in the availability of loans. Firms that need to raise debt are instead raising money through bonds.
'European banks have been scaling back their presence in Asia, and generic Basel III requirements have become more onerous. So we've seen a natural migration towards fixed income, as bank lending becomes more difficult,' says Citi's Woods.
In 2011, Asia Pacific (excluding Japan) raised US$125 billion in so-called G3 bonds (bonds issued in US dollars, yen or euros), according to Thomson Reuters. Asian issuers have already exceeded this level in the year to date, and full-year bond volumes are on track to be a record. (See chart).
So, there are push factors propelling Asian entities into bonds, but there are also pull factors.
Investors are exiting equity markets, and the euro zone generally. All that univested cash needs a home, and recently it's been coming to Asia to buy bonds.
Geoffrey Lunt, senior product specialist for fixed income, HSBC Global Asset Management, says there has been striking pickup in Hong Kong for bond funds, in particular for funds invested in high-yield US-dollar bonds from Asian firms.
He says HSBC in April 2011 launched a high-yield bond fund in Hong Kong that drew US$1.3 billion in three months - an unusually strong response.
Part of this is the natural rotation of money out of equities that occurs when share markets are volatile and money-losing.
'Macro overhangs in several large, developed economies ... has resulted in substantial fund flows out of other asset classes into fixed income,' says Biswaroop Barua, head of credit products, Wealth Management Group, Standard Chartered.
Eugene Choi, of Pictet Asset Management, says global investors are especially interested in Asian bonds because they think they offer stable growth. This is partly because many Asian economies are managed and are therefore steady - think, for example, of Beijing's heavy interventions when the economy is pressured.
From the perspective of bond investors, this is a good thing. It suggests stability, and the low likelihood of bond defaults. 'Investors want an emerging market but with less volatility ... Asia is attractive,' says Choi.
Furthermore - and in stark contrast to the beleaguered European debt markets - Asia is riding a ratings-upgrade wave. Moody's raised Indonesia's sovereign rating to investment grade in January and Standard & Poor's just raised the Philippines' rating. This improved the credit outlook of all firms based in those countries, and is consistent with the story that Asian growth is strong and that its issuers will only get more creditworthy. Global investors are putting money into what they view is a positive long-term trend.
For reference, Choi says foreign investors hold about one-third of the local currency bonds issued in Malaysia and Indonesia.
Demand is also picking up among regional investors fed up with equity-market losses and volatility.
According to the Securities and Futures Commission data, about half the mutual funds offered in Hong Kong this year have been dedicated bond funds, which is above average.
Hong Kong investors have switched gears. In the past people were infatuated with high-risk, high-return investments such as initial public offerings, warrants and mind-bendingly complicated structured products. Nowadays, much of that money is going into bonds, among the simplest and most stable of all assets.
'There has been a change in investor behaviour - people now think investing is less about capital appreciation and more about yield generation. Asian credits are paying attractive yields in an environment of low or even zero interest rates - so 4 per cent to 5 per cent on a bond looks attractive now,' says Woods.
The ideal bond in this environment is at the edge of investment grade, or just below. Individual investors find it hard to excited about the yields for issuers rated Single A or above, says John Wade, head of debt capital markets and syndicate, Asia Pacific, RBS. People may be rotating out of equities and other volatile assets, but they have not completely lost their taste for risk. They want returns that will make a meaningful impact on their wealth levels.
'People would love to see a Chinese property company come at a 10 per cent to 12 per cent coupon. Chinese property bonds have done very well,' says Wade.
Otherwise, Korean issuers are very popular right now. The economy is making the transition from 'emerging' to 'developed', at least in the eyes of market index firms that track such matters. Investors see Korea as a mature economy that ranks among the world's rich nations. Moody's may rate France four notches above Korea, but in the eyes of many investors, Korea has a far less complicated credit profile than its Gallic counterpart.
'When Korea was emerging, people treated its corporate bonds with caution,' says Pictet's Choi. 'Now people feel more comfortable - the Korean economy has matured. There is country-specific credibility for Korean corporate bonds.'
Wade of RBS adds that so-called hybrid capital is getting a lot of interest from private bank clients. Hybrids are debt instruments with equity-like traits, and are therefore slightly riskier (and higher yielding). Many institution funds are prevented by internal rules from holding hybrids, leaving the market wide open to private banking clients, who often buy these deals in bulk.
For example, Hutchison Whampoa issued a US$1 billion perpetual bond in May with a 6 per cent coupon. The coupon was richer than what would be seen on a vanilla bond from Hutch, and the offer therefore drew keen interest.
Forget the gloomy headlines. Boom times are back - in bonds.