Bond managers reeling from PBoC's devaluation

The PBoC's surprise 1.9% devaluation of the renminbi has left a hole in bond fund managers’ portfolios. Economists and managers say the coming week will be crucial in seeing what was behind the move.
Bond managers reeling from PBoC's devaluation

China’s shock devaluation of the renminbi is set to have a damaging effect on bond fund managers since most of their portfolios are not hedged for currency risk.

After yesterday's move by the Chinese central bank took markets by surprise, Hong Kong bond fund managers said the heightened volatility meant they would need to refashion their strategies.

It comes amid growing fears of a ‘”currency war” in Asia, with other central banks in the region also devaluing in recent months.

The People’s Bank of China yesterday (August 11) devalued the renminbi by 1.9%, which was the biggest one-day move for the currency since 2005. The PBoC moved the daily fix – around which the renminbi may trade within a tight band – from Rmb6.1162 to the dollar to Rmb6.2298.

The central bank also changed how it arrives at the daily reference rate, from a moving average of the past 10 trading days, to the previous day’s close. The offshore market rate depreciated a further 1.5% yesterday in Asia time.

The move took investors completely by surprise.

“It is similar to the Swiss franc’s situation earlier this year,” said Meng Xiaoning, Hong Kong-based fixed income portfolio manager at CSOP Asset Management, referring to the Swiss National Bank’s sudden end of the franc’s peg to the euro. “Market volatility has surged significantly, it is unavoidably a negative factor, and [investors] may need time to reposition the investment strategies.”

The relatively high cost of hedging currency risk means few managers are likely to be protected, so anyone invested in renminbi-denominated bonds yesterday suffered close to a 2% loss, Meng said.

Now the question investors have is whether this is going to be a one-off move by Chinese authorities, or if it sets a precedent for future changes. Managers are hopeful that offshore renminbi-denominated bonds, also known as dim sum bonds, will retain their lustre.

Eric Liu, Hong Kong-based fixed income portfolio manager at Manulife Asset Management, said: “As long as we can agree this is not a trend of significant depreciation, offshore-renminbi fixed income will still be attractive, due to its higher absolute yield.”

An offshore 10-year China government bond provided a yield of 3.46% yesterday, while a dim sum bond with a May 2016 maturity from Fantasia, a high-yield Chinese developer, offered a yield of 11.8% on Tuesday.

Economists initially saw the devaluation as a way to help China meet conditions set by the International Monetary Fund for including the renminbi within its special drawing rights (SDR) accounting unit.

But the act has come at a time when many governments, including those in Asia, are actively devaluing currencies to boost competitiveness - both the Indonesian rupiah and Malaysian ringgit have respectively devalued by 9% and 12% against the dollar this year.

Whether it is a reformist or stimulative move, both Meng and Liu said the central bank’s fixing rate over the coming week would be crucial. If it does not continue to depreciate against the dollar, it would confirm market observers’ belief that the PBoC’s move was about fulfilling the IMF’s requirements for its SDR basket. 

“I do not expect it will keep depreciating,” said Liu.

Investors and economists have not been convinced that the devaluation was part of a Chinese policy shift designed to boost its economy.

Chi Lo, senior Greater China economist at BNP Paribas Investment Partners, said a renminbi devaluation would not help China’s exports much as the exchange rate was not significant in affecting its trade, but it could lead to destabilising capital outflows fuelled by expectations of further depreciation. It would also exacerbate Chinese companies’ financial burdens with their unhedged foreign currency (mainly dollar) debt.

Most bond investors and economists that AsianInvestor spoke to believed the move was a responsive action to the IMF’s SDR review last week, as the report demanded a market-based “representative” renminbi rate. The report also criticised the current fixing rate as an inappropriate reference exchange rate to be used in SDR calculations.

Zhu Haibin, Hong Kong-based chief China economist at JP Morgan, said the IMF report suggested the PBoC’s fixing rate should be responsive to changes in market conditions, and yesterday’s action showed that the central band was moving in that direction.

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