It used to be the syndicate manager’s most blatant lie: “The bonds were placed mainly with accounts in Asia ex-Japan.” That, everyone knew, meant that the lead manager still owned most of the bonds.
How times have changed. Nowadays, institutions in Asia do very often buy up a large chunk of new issues. Goldman Sachs, for example, estimates that about one-third of the global bonds and jumbo Eurobonds in deals it lead-managed last year were placed in non-Japan Asia (and about another 15% in Japan). “A couple of years ago, Asian investors were important,” says Kipp Nelson, a managing director at Goldman Sachs in Hong Kong. “But now these investors often drive deals.”
The reason for the rise of Asian investors is easy to explain. It is mostly due to rapid build-up of reserves by the region’s central banks (see chart). The foreign exchange reserves of the 11 biggest central banks in Asia have grown from $324.92 billion in 1992 to $678.05 billion at the end of last year.
The growth in China’s reserves has been particularly spectacular: they have multiplied by more than four times in as many years to over $100 billion. Such is China’s demand for fixed-income instruments in which to invest these reserves that, according to Raymond Lo, a director at Salomon Brothers in Hong Kong, its central bank “almost automatically buys any new Eurobond which fits its investment criteria”. The results of this can also be seen in the US treasury market, where China is now the fifth largest foreign holder of treasury securities (after Japan, the UK, Germany and the Netherlands Antilles). China’s holdings of treasuries have more than doubled to $43.2 billion in just two years (see chart). You could argue that after July, adding Hong Kong’s $26.3 billion to the figure, greater China will be the third largest foreign investor in US government paper.
But central banks are not the only investors in Asia with growing amounts of money to spend. A range of new investors with an appetite for more speculative securities is also broadening the type of bonds which investment banks can place in Asia. Rich individuals and small banks increasingly buy high-yield bonds, including local currency paper from emerging markets. The Hong Kong and Singapore branches of international banks are now more inclined to buy bonds, whereas in the past they stuck to participating in syndicated loans. And, most encouragingly, there is a new breed of western-style institutional investor from mutual funds to pension schemes putting growing amounts of money into the world’s bond markets.
Lehman Brothers, for example, last month launched a $750 million floating-rate note for Ford Motor Credit targeted at Asian investors. On a fixed-rate issue for Ford in 1996, also targeted at Asian buyers, only 30% of paper was placed in the region. This time, according to Lehman, more than 40% of distribution was in Asia. “Five years ago, you wouldn’t have done a deal like this,” says Allen Cutler, a senior vice president in debt capital markets at Lehman in Hong Kong, “there just wasn’t the money around in Asia.”
Central banks are by some margin the region’s biggest bond buyers. And, excitingly for investment bankers, they are becoming a little less conservative about what they will invest in. Traditionally, Asian central banks could buy only AA or AAA rated sovereign or supranational paper. They rarely bought bonds with maturities of more than five years and stuck to the three or four most international currencies. Most could buy issues only above a certain size typically $300 million and were restricted to a certain percentage of each issue. Few would touch derivatives.
As interest rates worldwide have fallen, central banks like other investors have been forced to loosen their investment criteria in order to maintain their returns. “Central banks want more yield,” says Lehman’s Cutler, “so they’ve had to go down the credit spectrum a little.” Some of the Asian central banks will now selectively buy single-A paper, and are extending duration.
China is possibly the most adventurous central bank in the region. With $30 billion in new funds to invest each year, it has little choice. China also faces the problem that it has considerably more reserves than it needs for trade purposes or to tune monetary policy. (It has run up its reserves in a so far successful attempt to prevent the renminbi appreciating too fast.) It also has foreign debts almost exactly equal to its reserves. “Because it is reserved well beyond its liquidity needs, it needs to manage the funds properly and outperform the cost of its liabilities,” says a banker in Hong Kong who covers central banks. China can borrow in the international markets at 80 or 90 basis points over US treasuries. “Therefore,” says the banker, “it can’t invest just in five-year treasury bonds.”
Admits Lu Nanping, a director at the State Administration of Foreign Exchange (SAFE), the agency which invests the reserves on behalf of the central bank: “We are under huge pressure to manage such large sums well. We have been working hard to borrow skills from the international markets.”
Bankers who deal with SAFE say that it hasn’t relaxed its credit guidelines (it still buys only sovereign and bank AAA names), but it has become more adventurous with duration. It now regularly buys 10-year bonds, and has been known to invest in 30-year US treasuries. SAFE has also begun to use advanced hedging tools, such as options. It will even write an option when it wants to reduce its exposure to a currency without selling the underlying securities. “They’re a little bit more aggressive than the other central banks we deal with,” says Salomon’s Lo.
Better safe than sorry
Bankers also report that SAFE (which was known as the SAEC State Administration of Exchange Controls until last October) is noticeably more sophisticated than a couple of years ago despite still having only three or four professionals handling its long-dated portfolio. “They used to parcel a lot of the management out to the Bank of China,” says one western investment banker. “But now they do most in-house. They’re getting much more professional in terms of fund management.” Its order-size means SAFE gets the best possible service from bond salesmen. “They’re very well informed,” says Lo at Salomon, “because so many people talk to them.”
The investment binge is likely to continue in 1997. Says SAFE’s Lu: “Because monetary policy remains tight to restrict credit, there will be some growth in reserves in 1997, but perhaps at a slower pace than in previous years.”
If SAFE is Asia’s most aggressive central bank investor, the Hong Kong Monetary Authority (HKMA) is its most respected. HKMA remains conservative in its investment criteria. According to bankers, its buys only G7 currencies with a maximum maturity of 10 years. But it is also willing to put some money in equities or index products. It is also keen on using outside managers. According to Amy Yip, the executive director in charge of Hong Kong’s Exchange Fund (the territory’s reserves), about 25% of its assets are run by external money managers probably more than any other Asian central bank. (Yip herself is an example of the authority’s willingness to bring in outside talent. She joined the HKMA in October, having been a money manager at Citicorp and Rothschild.)
It is unclear, though, how much credit exposure HKMA is prepared to take. One banker in Hong Kong claims that the authority “is being forced [by low interest rates] to take credit exposure”. He, and other bankers, reckon the HKMA will now buy single-A credits, and is particularly keen on regional credits such as Korea (rated AA-/A1). Yip, however, denies this. “The last thing we want to do is go down the credit curve,” she says. “We won’t take single-A risk.” The extensive use of external managers does, however, allow HKMA, to loosen its rules. The external managers, for example, are allowed to use derivatives, which are banned for the in-house portfolio.
The HKMA is also praised for its transparency. Its annual report is probably more forthcoming on the details of its investment strategy than that of any other central bank in the world. It even reveals the split of the assets into a hedging portfolio (to hedge the Fund’s liabilities), a liquidity portfolio and an investment portfolio.
At the other extreme is Singapore’s Government Investment Corporation (GIC), a secretive body which doesn’t even reveal what its assets total (informed observers in Singapore suggest US$60 billion). It is not strictly a central bank although it does, along with the ultra-conservative Monetary Authority of Singapore, manage part of the country’s foreign-exchange reserves. Rather, GIC invests a number of pools of government money including a portion (how much is not revealed) of the Central Provident Fund. “In essence, it manages the reserves of Singapore Inc,” says GIC watcher Catherine Ong, a journalist with the local Business Times.
GIC is an aggressive, innovative institution that will buy anything from gold mines in Australia to hotels in Hong Kong. Its international investments are all run out of London and New York, away from the stifling atmosphere of Singapore. “It’s almost like a hedge fund,” says a Hong Kong-based banker. “The New York team is particularly aggressive. They’ll even take positions in Brady bonds and sub-investment grade debt no central bank in the world does that. They’re simply out to make as much money as they can.”
GIC’s free-wheeling ways have, however, produced a number of scandals in recent months that some bankers fear may force it to tone down its activities. In December, a GIC manager was charged with corruption for receiving more than S$2 million from Rockefeller & Co, a Hong Kong money management firm, which managed some GIC money. The same month, the Singapore government revealed it had found nine cases where foreign-exchange trading limits had been breached by the GIC. Another allegation, reported in the Singapore press in November, linked the GIC with an attempt to launder drugs money from Burma. The Singapore government denied the money-laundering allegation and, under attack from opposition members of parliament, offered to set up an official inquiry.
Other Asian central banks are big, but less exciting. The Koreans (with reserves of $32.8 billion) will buy only triple-A sovereign paper. Taiwan’s Central Bank of China (reserves: $87.7 billion) buys sovereigns rated double-A or better, but is increasingly willing to buy paper with a maturity of more than five years, especially in European currencies. India (where reserves have grown from $5.7 billion to $18.8 billion in the past four years) is an increasingly active investor. Macau ($20 billion) has declined in importance, having spent some of its holdings on its new (but under-used) airport.
Alongside the government investors, Asian banks are becoming bigger buyers of international bonds. Lehman’s Euro-Asian deal for Ford, was largely placed with banks (mainly because it was floating-rate). Many of these buyers are the Asian branches of big international banks. Says Goldman’s Nelson: “In Asia, there are thousands of foreign banks that want to extend credit.”
But, in the past year, Korean banks have also become important players. Investment bankers describe their purchases as “funding trades”. As part of the Korean central bank’s policy to sterilize the big inflows of capital into the stock market, it encourages its financial institutions to invest overseas. It does this by allowing them access to cheap funding, lent under duress by local insurance companies. “Because Korean banks’ funding costs are so low, it’s easy for them to lock in a profit with a credit trade,” says a Japanese banker in Hong Kong.
The smaller Korean banks, for example regional banks and securities houses, because their funding costs are higher, have to be particularly aggressive about which credits they buy in order to make a spread. They usually fund themselves at 50 or 60 basis points over Libor. Accordingly, they are keen to buy Mexican and Argentinian Eurobonds, Indonesian bank paper, subordinated debt, even GKOs (rouble-denominated Russian government bonds). “Our in-house joke,” says the Japanese banker, “is ‘Where on earth can we sell this paper?’ The answer: ‘Call the Koreans’.”
The Korean buyers, though, are still narrow-minded about who they will buy from. “They are like the Japanese 10 or 15 years ago,” says an American investment banker in Hong Kong. “They talk only to their own people.” Most of the big international banks therefore employ a couple of Korean nationals as bond salesmen in Hong Kong, and maybe another based in Tokyo.
Rich individuals are also buying more Eurobonds. “Private investors drive a lot of deals,” says Tom Chang, head of sales at Goldman Sachs in Hong Kong. “This phenomenon has been going on for a couple of years. Their wealth is growing and these investors have begun to diversify [away from equities] into bonds.” Higher-yielding bonds from emerging markets are often snapped up by rich individuals. A bond salesman told Euromoney that one of his clients held no less than $250 million in peso-denominated Mexican paper.
Driven by the rich
Rich Asians have recently begun to buy more bonds from regional credits. For example, a $185 million deal in November for Indonesian plastics-maker Tri Polyta was, according to Alan Yamashita, a managing director at the bookrunner Merrill Lynch, “driven by Asian high-net worth buyers. Asian demand jump-started the issue” which was also sold into the US. Asian investors were attracted by the rich spread of 540 basis points over US treasuries. Such is the importance of individual clients that Merrill has 40 brokers in Hong Kong and 100 in Singapore covering these accounts.
New types of investors are coming on the scene. Until two years ago, there were no bond mutual funds in Asia that bought international fixed-income products. There are now at least a dozen, offered by international asset management companies such as Deutsche Bank Fund Management as well as by local firms such as Income Partners. Returns have been quite impressive: Merrill Lynch Asset Management’s four Asia Tiger funds, for example, have returned between 15.8% and 16.8% over the past 12 months.
But the size of these funds so far is small. None has assets of much more than $30 million. More tempting is the prospect that some of the big domestic mutual funds in Asia will begin to open to international investment. The mutual fund industry in Korea totals about $80 billion, in Singapore $50 billion, and in Taiwan $15 billion. At present, all are severely restricted in which overseas securities they can buy. They also invest mostly in equities. “The driving force behind any change,” says Ilex Lam, an associate director at Credit Suisse Asset Management in Hong Kong, “will be the attitude of the governments in these countries. Taiwan, for example, is about to increase the number of countries in which mutual fund assets can be invested.”
Moreover, according to Lam, Asian pension funds are increasingly buying bonds: “They like Asian securities, including fixed income. But the bond market in Asia is too small at present. Therefore there will be a growing appetite for global fixed-income product at least until the local market develops further.”
A number of Asian countries are in the process of setting up new pension schemes or reforming existing arrangements which will bring more funds into the pool available for investment in international bonds. Hong Kong’s Mandatory Pension Fund (based on the Singaporean model of a compulsory savings scheme) will begin operations next year, and will have an inflow of US$4 billion or US$5 billion in new money to invest each year. Thailand is also planning to introduce a compulsory scheme. The Philippines and Taiwan have similar plans to unify several existing pension schemes into a unified central provident fund. Malaysia is about to allow its Employee Provident Fund to invest a portion of its funds outside Malaysia, although this will mainly be in equities. Korea must also allow its pension funds to invest overseas as a condition of having joined the OECD.
Southeast Asian and Chinese investors are clearly destined to play a more important role in the global bond market. But the sums they have available to invest need to be put into proportion. Within Asia, Japanese investors still dominate. Japan’s largest investor, Kampo, has $844 billion under management; the country’s largest insurer, Nippon Life, has $367 billion. Compared to that China’s $100 billion of reserves, and the Singapore Central Provident Fund’s $42 billion of assets look puny. Says an investment banker: “In one square block of Marunouchi in Tokyo there’s more money than in the whole of the rest of Asia. Asia ex-Japan is still only a medium-sized investment market.”
