The Asian economies are making a rapid recovery. The financial markets are bouncing back and the bond markets enjoyed a boom year. But the prospects for 2000 are varied. Market players say that while total fee earnings are likely to be up with increased issuance - US investment bank JP Morgan expects gross government bond supply in the region to rise 20% to $135 billion this year - performance is likely to slip. This means the job of buying or selling bonds will be that much tougher.
"We do not look for another year of outsize performance numbers," says David Rolley, emerging-market debt strategist for Boston-based fund managers Loomis Sayles, which has $65 billion in funds under management. He points to the good performance by Asian bonds as an asset class in 1999. He cites the huge rally by Korean government long-term debt, which was about 450 basis points over US treasuries at the beginning of last year. By the end of the year, it was about 150bp over US treasuries. And that kind of performance appears, he says, not just in Korean securities but right through the region.
"Most bonds in Asia have done very well. But now with these new, much tighter, spreads - the fact that investment-grade bonds now trade at investment grade spreads rather than a single-B or double-B credit - you cannot expect the same performance from Asian securities in 2000 as we did in 1999," he says.
JP Morgan describes Asia's local bond markets as a new and rapidly rising asset class. Bernhard Eschweiler, head of the bank's economic research team for Asia, says: "Asian local markets offer attractive opportunities for global and emerging markets bond investors who look for growth, diversification and yield pick-up."
Even if yields turn out to be less attractive in the coming year, Asian bonds are attractive to fund managers. The region's fortunes have turned and Asian bonds offer the chance of diversification into a market where growth and profits look set to do well.
Patricia Goodstadt, portfolio manager at Barings Asset Management's global fixed income department, which is responsible for emerging-market bonds and has $23 billion under management, says: "Much of the Asian credit improvement story has been factored into current yield levels. For investment-grade funds, Asia could be an attractive diversification out of G7 bonds and offering yield pickup over many equivalently-rated US-dollar corporate bonds. I think Asian bond markets will present many attractive investment opportunities for a variety of investors. For both dedicated emerging-market investors and opportunistic investment-grade and high-yield investors, Asia will offer good diversification benefits."
As a result of the financial crisis, a number of Asian issuers who had investment-grade ratings lost them, but now these ratings have come back. As spreads have tightened, there is demand now from the more traditional fund managers who can only hold investment grade. Donald Hannah, head of Salomon Smith Barney's Asia Pacific economic and market analysis team, says: "More pension funds and others can hold these bonds as opposed to the more traditional emerging market investors who are looking at countries like Russia or Argentina or Brazil where the credit rating is lower and the bond spreads are higher. A country like Korea trades at 150 over US treasuries and that difference is a reflection of country risk, not credit rating."
Investment in 1999 was mostly driven by the macro-economy, according to fund managers. Decisions were based on views on interest rates, economic growth, inflation and other macro-factors. But this year, it is not that simple. Even though the macro-economic backdrop for the bond market is pretty strong throughout the region - JP Morgan predicts overall GDP for Asia, excluding Japan, will grow at an annualized rate of 7.2% in the first quarter - investors need to pick and choose individual credits and evaluate them on their own merits much more carefully.
Emil Nguy, managing director of Income Partners Asset Management, a Hong Kong-based fund management company specializing in Asian fixed income and investment, says: "It used to be you did your calculations according to macro-fundamentals in the region. Today, in the market, it is too difficult to do that. There is too much disparity among credits within a country. In fact, the disparity between companies within a country may be bigger than across countries.
"You look at companies very specifically. You look across the whole credit curve. You look at the better quality credits which, of course, tend to be in places such as Hong Kong, Taiwan and Singapore - a little bit lower down would be Korea or Malaysia or the Philippines, and a little bit lower down you get Thailand and Indonesia. We believe the best way to get a best return for 2000 is probably to get a fairly mixed portfolio of credit quality looking way down the credit quality curve."
The move away from relying solely on the macro-picture is a theme repeated by many strategists. The opportunities are now to be found, not so much in changes in the sovereign economic outlook, but in the prospects of individual companies.
Hong Kong-based Fan Jiang, who runs the fixed-income research team in Goldman Sachs (Asia), says: "The way we made money in 1999 was too easy because you just make a macro-bet. If you bet on Korea growing faster than China, you will be right. Whatever you are buying in Korea, you will make money and you don't have to do all the homework. You just bet on macro. If you bet on the Philippines growing a little less than Malaysia, then you sell the Philippines and buy Malaysia. It didn't matter what you did- as long as you bet on the right country, you made money.
"Year 2000 won't be that easy. Year 2000 will be a major breakout whereby fundamental credit quality and valuation will matter."
Jiang believes money can be made by looking for growth opportunities with absolute returns as well as looking for relatively cheaper bonds, realizing relative value. He cites Korea's Samsung Electronics and Hong Kong's Hutchison Whampoa as good examples of absolute returns - what he calls the growth story - despite the tightening of spreads since the crisis.
Samsung Electronics at the height of the crisis went out to 17%-18% per annum; it is now down all the way to 8.5%. Hutchison Whampoa's 10-year bonds stood at 8.5%-9% per annum; now it is about 7%.
As for relative value, he looks to the Philippines, which he thinks has been undervalued because people overplay its Latin American characteristics. He points out that when you compare the Philippines with other parts of the region, it becomes relatively attractive, taking into account how much one pays for Philippines bonds compared with what one pays in Thailand and China.
"It's relative-value realization. They may not grow very fast - either the underlying business or the bond itself - but they will perform well because they are relatively cheaper," he says.
The recent HSBC Philippines-led fixed-rate corporate note facility for PLDT has been hailed as marking the birth of a Philippines bond market. The first peso-denominated fixed-rate offering by a local corporate, it is a benchmark issue. The notes total Ps1.5 billion ($37.5 million). Issued in three tranches of three, five and seven years, they are virtually identical to the national government's fixed-rate treasury notes. Demand was so strong that it was possible to achieve much tighter pricing than originally expected. HSBC was able to bring down the instrument's rates by as much as 25bp from initial indications. The spreads were finalized at 62.5bp, 75bp and 87.5bp over comparable treasury benchmarks. The issue, awarded on an auction basis, was kept domestic.
Also impressed with the Philippines is Nguy of Income Partners: "They have shown themselves to be very astute issuers in the market. They press a button - boom, retire an old bond and issue a new one."
He was talking about the Republic's global bond offer last October, of which half was new cash and half involved exchanging existing Brady bonds. The target was a minimum offer of $500 million. The government expected more deficits over the next few years and thought it would be wise to get rid of some of the amortizing Brady bonds to relieve the heavy debt servicing burden.
The region's media reported that the arrangers were offered a 10bp fee as an incentive to guarantee the $250 million target for the exchange offer beforehand. The arrangers turned it down. They must have kicked themselves: despite deteriorating market conditions, astute pricing and good marketing resulted in $1 billion - twice the minimum target - eventually being raised.
Hannah of Salomon Smith Barney, says: "The Philippines has economic fundamentals that look far better than the performance of its sovereign bonds would indicate. But that's related to concerns about the president and his administration - so it's more politics than economics. So there is potential in the Philippines, if perceptions change about the president and policies, for bonds to outperform relative to other Asian bonds."
The Philippines is just one story. Across the region, there are other signs that local bond market activity is picking up substantially. With the likelihood of interest rates in the US going higher and those in cash-rich Asia being kept low, many analysts believe that the region's bond markets are in for a boost.
Governments will issue. They are driven by the rising interest-rate expenses stemming from their programmes to bail out troubled banks, a desire to develop domestic bond markets and the need to meet an increase in maturing debt.
JP Morgan forecasts gross issuance by Asian governments in domestic bond markets to increase $22 billion this year - a rise of 20% to about $135 billion. Overall, the amount of outstanding central government bonds is likely to reach $476 billion by the end of this year. It expects gross issuance of domestic government bonds to account for nearly 10% of the equivalent in OECD markets in 2000 and says it is likely to double over the next three to five years.
Rolley of Loomis Sayles says: "We could see a greater supply [of issues]. We could see more investment banking activity, more prospectuses, more new deals, more deal activity in the year 2000 than we saw in 1999."
Corporates will also issue. Salomon Smith Barney sees increased domestic corporate issuance replacing bank funding in Asia. Hannah says: "Banks aren't lending. Better-name corporates would prefer to avoid the high cost of bank debt by issuing directly."
Moreover, many companies that had borrowed in dollars before the crisis did not count the exchange risk and found the ultimate cost of that borrowing to be far higher despite the low nominal coupon. Now they are willing to take higher domestic interest rates because of the greater certainty.
Investment manager Jiffriy Chandra of Income Partners Asset Management, gave a ballpark figure on the amount of issuance he expects to come to market: "We've made a count of what's been rumoured in the market. And, if you add up all those, the range is $8 billion to $10 billion for the first quarter. A lot of them may not come but it is an indication of how many deals are being worked on by investment banks."
The Singapore bond market, too, is poised for take-off. JP Morgan expects a significant expansion of the market this year - with new issuance rising to S$2.7 billion ($1.5 billion) compared with S$1.7 billion in 1999. The main impetus is a continuing drive by the local authorities to establish Singapore as the region's securities hub. Thus, despite a healthy fiscal outlook, which greatly diminishes the actual need for government borrowing, issuance is likely to resume rising.
Singapore-based Rebecca Paterson, JP Morgan's Asian markets strategist, says: "This year will undoubtedly bring increasing Singapore bond supply: S$5.4 billion worth of bonds will mature mainly in the third quarter. While this forecast implies steady upward pressure on local rates, we expect such pressure to be limited."
Many Singapore companies have emerged relatively unscathed from the Asian crisis. They have increasing amounts of cash, which needs to be invested. It is likely that most asset allocation will remain domestic. "We expect this increasing demand for assets to local entities to mop up a good deal of issuance this year," she says.
A centrally-planned bond market
The Singapore authorities are actively encouraging a bond market. The government has begun to open up the market to new issuers, to push the advancement of fixed income investment and encourage a culture of fixed-income investment among life insurers and the pension funds. It lifted restrictions on issuance and opened the market to new issuers to give investors a broader investment universe.
Although it does not need to issue bonds because of the healthy fiscal outlook, it has introduced a bond auction schedule and extended the yield curve out to 10 years in the hope that other issuers will fill up the market. In 12 months, it has gone from being a closed market to being the second largest market for foreigners. Last year, foreign issuance was $1.6 billion, according to Salomon Smith Barney.
Hong Kong, in common with Singapore, does not rely on issuing debt to fund its fiscal position - the government traditionally runs a budget surplus. The Hong Kong Exchange Fund issues paper solely to provide benchmarks for the local bond market. Paper has been issued only when there was an inflow of funds, ensuring that all new issues would be fully backed by foreign reserves.
Researcher Hsin-Li Chia of JP Morgan expects that with a continued economic recovery, stronger goods and services balance, and increased capital inflows, the Exchange Fund's holdings of foreign assets will go up.
She expects net issuance of Exchange Fund notes to rise from last year's HK$0.5 billion ($64 million) to HK$3.6 billion this year. She says: "Net issuance in 2000 will probably be concentrated in the seven-year and 10-year sectors."
The Hong Kong dollar bond market, according to Barings' Goodstadt, should develop and deepen in the next few years. During the past few years there has been a big increase in the number of issues, range of issuers and of maturities. The World Bank has issued a benchmark issue denominated in Hong Kong dollars - a liquid issue by a strong credit with worldwide name recognition.
She says: "We are seeing a structural change driving the Hong Kong dollar bond market today, both from the supply side - as the government refines its monetary management techniques - and the demand side, notably from pension development in Hong Kong. Domestic and external investors benefit from the expansion of Hong Kong dollar bond issuance, both in terms of market capitalization and across a range of bond maturities. The demand for Hong Kong dollar bonds will grow as pension provisions improve."
The market considered by many strategists as being one of the most risky in the region is Indonesia. But Jiang of Goldman Sachs sees opportunity. He points out that the country is now running an impressive trade surplus and he suggests that investors keep an eye on the current account - "that's what took Korea from rags to riches so quickly".
The risk is on the political side, he says. "If president Wahid can keep the country together, which is what we're ultimately betting, then Indonesia exchange loans look very cheap, especially compared with the Indonesia '06 trading 400bp tighter.''
Indonesia's domestic debt market is predominantly made up of central bank paper; about Rp72.7 trillion ($9.9 billion) is outstanding while corporate bonds stand at some Rp15.6 trillion. Last year, the government issued Rp260.6 trillion as part of its bank recapitalization programme. The bonds were not issued into the market but were directly placed with banks in exchange for stock.
Chia of JP Morgan says: "The restructuring programme ground to a halt in the face of political uncertainty in the second half of 1999; however, more issuance is now expected as the programme gets underway again. Overall, the government is planning to issue Rp351.6 trillion of treasury bonds.
"Initially, bonds were not to be traded, ostensibly to avoid Y2K issues, but clearly also to prevent flooding the secondary market. Banks will be allowed to trade bonds in 2000 but liquidity is likely to remain thin."
Like its phone watches, Samsung's bonds are a good buy, if not as cheap as they were
