Without fundamental changes – and, possibly, some type of regulatory intervention – the allure of HKD bonds will come under ever-greater scrutiny, even among those asset owners that are its core buyers.
This is according to many investors – mostly locally based insurance companies – who spoke to AsianInvestor to highlight key themes from the results of an exclusive survey conducted by the publication in November and December 2019, in association with HSBC Global Asset Management (HSBC AMG).
Out of around 100 respondents in Hong Kong and surrounding key markets, only 16% of respondents – mainly insurers – said they plan to increase exposure to HKD bonds over the next 12 months. This compares with 42% who answer positively to the same question in an equivalent survey by AsianInvestor and HSBC AMG in mid-2017.
The outcome is especially notable given this is a community of investors that want such assets to benefit from attributes they offer, such as asset-liability matching, low currency risk and high-quality names.
Yet even these active buyers with vast pools of real money that need a home are potentially losing some interest in given various shortcomings in HKD bonds. These include, for example, their relatively lower yield and returns (according to 37% of respondents), the limited choice of issuers (34%) and the credit outlook for these assets (16%).
Building on this feedback, asset owners who responded to the survey identified three key ways that they want to see the HKD bond market develop further:
- A broader credit universe by having more corporate issuers
- More liquidity in the HKD bond market
- More HKD bond market makers
Making more of the market
Speaking on condition of anonymity, many leading Hong Kong-based insurers – measured by AUM in their investment portfolio – identified several far-reaching changes they want to see to drive their HKD bond allocations going forward:
- Much longer tenors to meet their need for duration, plus to provide a benchmark at the longer end of the curve
- A much wider range of issuers, especially corporate names and on a more consistent basis
- More secondary market liquidity with greater evidence of this type of demand
With HKD bonds typically having maturities of around 10 years, several investors at different types of insurance companies said the asset doesn’t really meet the key requirements of these asset owners. Further, as a private placement-driven market, the breadth and depth that exists for bonds denominated in US dollars, euros and British pounds, for example, is lacking. By default, this also raises a concern in terms of concentration risk in HKD bonds.
“If there was more issuance from corporates, plus options to buy bonds with longer tenors, especially ones with decent spreads, then appetite for HKD bonds would be a lot bigger among insurance investors,” said a senior investment executive at one of the largest global insurers.
While the high quality of existing issuers – from government entities to financial institutions – has its benefits, it also means that investors cannot expect to get much in the way of a credit spread, explained Cecilia Chan, chief investment officer for fixed income at HSBC AMG in Asia-Pacific.
“This is related to the limited universe of issuers, so it would be good to have wider spreads available as an option. Also, if liquidity was better, this would also make HKD bonds more attractive to [institutional] investors,” she added.
This latter issue represents a constant struggle for some insurers, added a senior risk professional working within a large in-house investment team. Without confidence in the availability of liquidity, for instance, asset owners lack comfort that they could sell their HKD bonds if they needed to.
Encouraging a shift from a relatively short-term mind set towards one where a more diverse range of corporates issue longer-dated bonds might in fact only be realistic if it is driven by some type of government initiative – or, perhaps, regulation.
“The government needs to do something about the need for more activity at the long end of the curve, such as incentives for other credit issuers to enter market,” said a senior investor. “It could be part of wider efforts, for instance developing infrastructure assets.”
Another potential way to foster change might exist by way of guidelines in relation to pension investing, added Chan at HSBC AMG. “The MPF guidelines in Hong Kong require 30% of assets to be invested in HKD investments, but there is no mention of in which asset class. So, if this could be implied for HKD bonds, for example, then naturally this will increase demand,” she explained.
If asset owners’ concerns are left unaddressed, however, USD bonds have the potential to make more in-roads in investor portfolios.
In response to a question in the recent survey, for example, 65% of investors said they would buy USD bonds as a partial hedge for HKD bonds for their HKD liability matching requirements. The availability of paper with longer maturity is one of the main advantages. Meanwhile, only 16% of respondents said they would maintain their exposure to HKD bonds for their liability (the remaining 19% confirmed that they do not have a HKD liability matching requirement.
The availability of longer-dated USD bonds also serve as a way for some insurance companies to take advantage of any rebound in rates to reduce the duration gap they might be grappling with.
For insurance investors and other asset owners that derive benefits from HKD bonds in their portfolio, the way they access these assets might well evolve to some extent.
To date, larger institutions have opted for a buy-and-hold approach given their asset-liability matching requirements. Further, this can give them a bit more opportunity to customise a deal.
Yet the results of the survey, both among current and prospective HKD bond investors, showed a growing appetite to get exposure via a HKD bond index ETF.
This differed from the views of survey participants in mid-2017, when 49% said they preferred to invest into HKD bonds as part of an actively managed Asian corporate fixed income portfolio. However, a small portion of investors at that time did acknowledge a preference for passive investment strategies, including a HKD ETF, mainly for flexibility, convenience and liquidity, as well as lower fees and the ability to gain exposure to a broader HKD bond investment universe.
In fact, as shown by the charts below, the greater interest in 2019 in accessing HKD bonds via an ETF is notable since respondents were asked to indicate their top three options from seven strategies. This compared with a range of just three strategies to select from in 2017.
Such an alternative option might for HKD bond exposure, for example, be the Hong Kong Dollar Bond Index ETF, which is managed by HSBC AMG.
According to Chan, insurance investors face a growing need for target return but low volatility assets. In turn, this paves the way for more defensive investments.
Meanwhile, the upcoming risk-based capital framework in HK will mean that holding bonds directly will attract equal or less capital charges than additional vehicles or layers. This will be a particular boost for local insurers and a natural demand driver for HKD bonds.
For more information on the HSBC ABF Hong Kong Dollar Bond Index Fund, please click here.