Making the grade
Source: REUTERS/Bobby Yip
The flight of international investors out of emerging markets last spring seems like a distant memory in Asia, having seen a strong return of funds to the region this year.
Investors fled thinking rates in the US would rise, providing higher-yielding securities in the US with deeper more liquid bond markets. Yet, issuers out of Asia, excluding Japan and Australia, have easily found buyers for a combined US$72.1bn of US dollar bonds alone through the middle of this month, as US rates have stayed low, showing the emerging-market exodus was misguided.
Emerging-market bond funds received new funds of US$1.16bn in the week ending May 14, marking the seventh consecutive week of inflows, according to fund tracker EPFR. In the first week of May alone, bond funds collectively absorbed US$8.97bn – a three-month high.
Clearly, the higher yield on Asian bonds, relative to similarly rated Western paper, is one reason investors buy them. However, Asia also has a growing number of locally based investors with a huge appetite for foreign-currency bonds out of Asia. Private banks, which cater to Asia’s wealthy, also are broadening their investing scope away from high-yield securities to investment-grade bonds.
All of this contributes to an expanding investor base, a healthy sign for Asia’s growing capital markets. Yet, investors throughout the region have different approaches, which may take some time to resolve.
Asian investors, for instance, have a ways to go before they become as sophisticated as their Western counterparts, according to credit analysts.
“They have to go beyond fundamentals and start to look into technicals,” said a Singapore-based analyst. “Portfolio managers (from international firms), so far, are the only ones that seem to get into technicals, but Asian investors will need to mature and that will come with experience.”
Among technical issues that analysts cite are financial details outlined in a company’s prospectus, analysis of comparable bonds and the profiles of other potential investors. Deal fundamentals have more to do with how many times an issuer has tapped the market, bond covenants and an issuer’s track record.
‘’Amongst technical considerations, liquidity is a very important one,” said Alan Roch, head of bond syndicate, Asia Pacific at Royal Bank of Scotland. “Issuers are advised to provide liquidity in terms of either issue size or through regular transactions that build up a curve.”
Another concern is that Asian issuers tend to be more concerned with a bond’s absolute yield rather than its yield in comparison to a government benchmark or a comparable bond, which is how such paper is assessed in international markets.
“Investors are seeking diversification not only in names and industries, but also via the ability to invest in a wide maturity spectrum. By adding longer tenors in Asia, they add breadth to their funding and price tension to their curves.”
“Asian buyers tend to go for absolute yields or name familiarity,” said one debt syndicate banker. “They have to become more sophisticated in focusing not only on fundamentals, but technicals at the same time.”
The focus on absolute yield also trips up local investors, who hold paper to maturity when they buy international bonds. These investors often find they need to hedge against rate movements and currency exposure.
“If I don’t (hedge), I can easily get wiped out,” said a Malaysian investor interested in buying Asian bonds denominated in dollars or other currencies.
More than 75% of all US dollar bonds in Asia sold so far this year have been from high-quality banks and sovereigns, as well as frequent corporate borrowers, according to ANZ.
Investors are increasingly interested in these bonds. International funds, in particular, are buying big chunks of new investment-grade offerings out of Asia.
China Petrochemical Corp, or Sinopec, sold a US$5bn multi-tranche bond in early April in the largest bond from Asia in 11 years. US investors bought 70% of the three-year fixed-rate note and 62% of the three-year floating rate note, as well as 44% of the five-year fixed-rate bond, 50% of the five-year FRN and 62% of the 10-year bonds.
Good returns on Asian credits, thanks to an unexpected drop in US Treasury yields, are one reason for the international interest. Total returns for Asia’s investment-grade corporate bonds rose to 4.2% in mid-May from 3.7% in April, according to the JP Morgan Asia Credit Index.
Private banking accounts, meanwhile, also are turning to investment-grade offerings, believing they provide good returns, after focusing mostly on high-yield bonds. Private banks, for instance, bought an unusually large 27% of a US$500m five-year 4.25% bond from China Shipping. The bond, with an A1 rating from Moody’s, backed against a standby letter of credit.
Investors in Asia have preferred bonds with maturities of up to five years in part to avoid getting stuck with a low-yielding security in case rates rise. According to Thomson Reuters data, US$16.8bn of IG bonds sold in Asia so far this year had tenors of up to five years, more than the US$15.4bn of bonds in short-dated paper sold in 2013.
“Given the uncertainty on the US Treasury yields, and not knowing when the interest rates could be raised, we will adhere to the short-duration theme,” said Nancy Koh, a senior vice-president and head of fixed-income research at DBS Bank.
That does not mean high-quality longer-dated bonds cannot find buyers. China National Offshore Oil Corp, or CNOOC, added a 30-year tranche to its US$4bn issue in late April. The longer-dated US$500m piece drew orders of US$3.6bn. An investor who bought more of the 30-year tranche than the 10-year one believes the relatively steep Treasury curve could flatten.
State Grid Corp of China’s US$3.5bn three-tranche transaction also included a 30-year tranche, which attracted US$1.8bn in orders.
“Investors are seeking diversification not only in names and industries, but also via the ability to invest in a wide maturity spectrum,” said Roch of RBS. “By adding longer tenors in Asia, they add breadth to their funding and price tension to their curves.”
The resurgent Asian market has extended to high-yield issues, which have performed well in the primary and secondary markets. Issuers are now pushing out refinancing needs for the rest of the year and for early 2015 before investor fatigue sets in and the plentiful supply causes indigestion.
Koh said investors should stay focused on the primary markets for the time being to take advantage of the premiums offered on new issues.
“Spreads in the US dollar high-grade space are expected to remain flattish in the near term, but we expect spreads to tighten in over the medium-term horizon, if market conditions remain stable and new supply starts to dwindle,” Koh said.
Although investors have found Asia to offer good relative value lately, market analysts caution that risks remain. The slowdown in China’s economy could have a big impact on the region, as many countries, and their companies, are directly prone to the world’ s second biggest economy. Economists project China’s GDP growth will slow to 7.1% in the second quarter of 2014 from 7.4% in the first quarter.
Bonds from PRC property companies have borne the brunt of these concerns over the last several months. Chinese IG property bonds widened 10bp 15bp in mid-May.
“Stay defensive,” said Pradeep Mohinani, head credit desk analyst for Asia at Nomura International. “Investment-grade bonds should continue to outperform high-yield, although we prefer the lower-beta ones for now.”
Investors should certainly bear that in mind as bonds emerge from lower IG credits in China.
“The potential new supply of BBB rated Chinese paper, together with China’s macro-economic factors, may add pressure on credit spreads of high-beta Chinese credits,” said Pradeep.
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