Are you long and wrong?
Investors have good reason to be cautious about corporate bonds. Global debt markets have ballooned to $100 trillion, three times the size of global equity markets. Yet there has been a sharp fall in banks acting as relative-value players – buying/selling bonds and providing backstops. Post-2008 rules such as Dodd-Frank, to discourage prop trading and increase capital requirements, has perversely increased liquidity risk in secondary markets.
Banks therefore are looking to cross trades rather than serve as dealers. You can see this in their inventories (see cover story on page 26). Trading in fixed income has likewise been decimated. Consider what happened in the 2011 European debt crisis. When Greek and Portuguese bonds collapsed, banks weren’t there to perform their liquidity function. Had they been, it’s unlikely we would have seen such extreme price movements.
Then consider how large-scale asset purchasing programmes from central banks have driven investors into high-yield and emerging market credit. Of the largest 300 asset owners in Asia, 70% of respondents to our survey plan to raise exposure to emerging market debt or move down the credit curve in the next 12 months (see page 10). From 2007 to 2013 emerging market bond funds tripled to $340 billion, prompting a warning over volatility and concentration risks from the Bank of International Settlements (see page 7).
The corporate bond world has become over-crowded and over-purchased. Removing banks as liquidity providers leaves the market to institutional buyers and asset managers, which as a herd are either long or short, but rarely both. In theory, long-term institutional investors don’t require daily liquidity. But before 2008 mutual funds accounted for 6% of global outstanding credit, today they own 24%; any run on bonds will leave fund management companies in a bind. This raises the prospect that marginal buyers can cause outsized problems, as retail ETF investors demonstrated in the high-yield space in July.
That was a contained incident. But the Federal Reserve is expected to raise rates next year. This will contract US dollar liquidity globally. So how can investors expect those emerging markets running current account deficits – and which refinance themselves short term by borrowing dollars – to outperform?
There could be a rush for the exits, and this new paradigm of illiquidity has not been tested on a large scale. When the next bear market comes along, caused perhaps by a credit or rate shock, the price plunge in corporate bond prices will be that much deeper in sectors where the quality has dried up. Spreads may move dramatically when people look to get trades done.
Investors should be planning now for spikes in volatility across the fixed-income market and to build a cash reserve to take advantage.
On the move
04 Eastspring names Japan CEO, creates HK intermediary job; Threadneedle opens office
in Seoul; OMGI hires Asian equity trio
06 Regulatory Analysis
Singapore seeks CPF reboot
07 Regulatory Roundup
BIS warning on EM funds; Singapore to simplify retail bond purchases
08 Data Centre
Hong Kong and Singapore are tipped to grow in importance as jurisdictions for incorporation, surpassing BVI and Cayman.
10 AI300 survey
Our survey of Asia’s leading asset owners finds increased appetite for allocating overseas and into alternatives.
16 Q&A: John Pearce, CIO of UniSuper
18 HKMA seeks new head of direct investment; MAS mulls family office framework
20 Is Vietnam ready for private banking?
VPBank Securities aims to create the country’s first onshore private bank, but faces hurdles if it is to succeed.
22 Q&A: Donna Cotter, Asia head of wealth management, Manulife
24 Cerulli flags distribution trends; private banks ‘losing identity’
26 Liquidity lost
Investors must learn to cope with the disappearance of market-makers in fixed income
30 Demand underpins depth of emerging-market debt
34 Portfolio managers hedging yen exposure
36 BNPP IP plans China wholly-owned entity,
eyes Japan overhaul; Taiwan’s tough line reflects regional trend
38 Private players strive to cross the divide
China’s private equity and venture capital managers plan to launch mutual fund firms, but the move will test them.
40 Q&A: Sanjay Gujral, L Capital Asia
42 Warburg Pincus hires Eddie Huang; Nomura AM agrees China JV; KKR hires Indonesia team
45 PE managers under pressure to outsource
Private equity firms have typically done their own fund administration, but that may be changing.
48 Roundtable: Hedge fund allocators and advisers discuss developments around the Fed and China.
54 Operations manager: Murray Steel, Asia COO of Man Group
56 SGX touts China hub credentials; family office concept gains traction
58 Chinese asset owners talk global diversification
Insurers are hesitant to venture overseas due to inexperience and fear of failure, but appetite for alternatives is on the rise, heard AsianInvestor’s China Investment Forum last month.
Indonesia Etc: Exploring the improbable nation.By Elisabeth Pisani