The Hong Kong Monetary Authority, on behalf of a group of the Asia-Pacific's central banks, has mandated State Street Global Advisors to manage the pan-Asian US dollar-denominated half of the $2 billion Asian Bond Fund-2. Now SSgA is preparing to expand the passive investment to private investors, including Asian retail and global institutional players.
The avenue to attracting retail investment from Hong Kong and Singapore investors will be via exchange-traded funds it plans to have authorized in those jurisdictions, says Vincent Duhamel, regional CEO at SSgA in Hong Kong. The fund will be listed on the Hong Kong Stock Exchange and SSgA hopes to have ETFs in the market this summer.
Duhamel believes the low-cost structure of an ETF - he hopes all-in fees will not surpass 30bp, versus around 75-100bp for a traditional bond fund - will generate a buzz. Lot sizes in the ETFs will also be much smaller than lots in bond issues, he says.
SSgA's own institutional sales team will target global investors keen to get a passive exposure to Asian fixed income.
ABF-2 follows the first Asian Bond Fund, a $1 billion portfolio of US dollar-denominated issuance from Asian sovereigns and quasi-sovereigns, passively managed by the Bank of International Settlements. The pan-Asian tranche of ABF-2 will invest in baskets of local currency bonds on an unhedged basis, with the total NAV expressed in US dollars. The assets are managed passively against an index provided by iBoxx, a unit of Dow Jones Indexes.
The other half of ABF-2 consists of eight purely local, actively traded local bond portfolios managed by domestic firms in China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore and Thailand. These mandates have also been awarded by the HKMA but calls to that organization were not returned by press time.
The sales pitch for Asian fixed income would include an average spread of 300-400bp over US Treasuries but with comparable volatility; improving credit ratings among Asian sovereigns and quasi-sovereigns; and the potential upside of Asian currencies.
The big drawback to this asset class, regardless of the instrument, is liquidity. There's very little supply. "Liquidity risk is a big item, but we're trying to be a solution to this problem," Duhamel says. "The whole point of the Asian Bond Funds is to help create a third leg in capital markets, along with equities and bank finance." He says if the ABF-2 is a success, that means it will have not only attracted other investors, but catalyzed third parties to issue or invest in Asian domestic bonds. "If this fund works, others will follow, and we can create a yield curve," he says.
Duhamel is sanguine about the lack of futures to help arbitrageurs keep the ETFs' NAVs in line with the price of the fund - an instrument typical in equity ETFs. "Our ETF in China doesn't have a futures market but it still works," he says. "If the price of the fund diverges too much from the NAV, a market maker will jump in and take that trade." The experience of the SSgA-managed Hong Kong Tracker Fund may be a useful guide: initially, the premium or discount could reach 150bp, but as brokers became familiar with the product, that has since narrowed to 30bp. This may prove trickier with fixed income, however, because the underlying market is so illiquid. Things like taxes, spreads and especially market impact can make transaction costs high.
Duhamel says judging the pan-Asian fund's success just by the asset size it reaches is too crude. Rather success will also depend on how much domestic bond markets improve liquidity, how accurately they develop yield curves and whether the pan-Asian fund truly reflects those yields.
The ABF project has been led by 11 regional central banks and monetary authorities, including those representing ABF-2's eight target markets, plus Japan, Australia and New Zealand.