For Asian bond portfolios, impressive performance in 2020 across most strategies – following central banks’ intervention amid Covid-19 – bodes well for flows this year into regional credit and local currency bonds as investors intensify their search for yield.
The lower-for-longer backdrop has led to credit spreads and higher yielding currencies becoming increasingly valuable. This is fuelled by limited volatility and chronically low levels of yield in benchmark government markets. “Credit spreads now make up a far greater proportion of overall bond yields, so to achieve yield targets, investors need to take some degree of credit risk,” said Ming Leap, fixed income portfolio manager for HSBC Asset Management.
Broadly, Asia’s robust macro fundamentals and likely economic rebound this year provide promising conditions for diversification, notably for global investors.
More specifically, a desire for shorter duration product coupled with a more defensive stance in regard to interest rates volatility will also steer more fixed income buyers towards the region, including HKD bonds.
In particular, for investors concerned about the uncertainty in today’s investment landscape, these bonds offer the type of low volatility, low credit risk, high quality alternative they are seeking, especially given the added incentive of a decent yield pick-up versus other highly-rated Asian local currency bond markets.
“More importantly, HKD bonds, given their shorter durations and the high quality of the credit signature, make sense as a refuge if the recent increase in yield in US Treasuries marks the start of a longer term trend,” said Leap.
Building on solid foundations
Including Exchange Fund Bills, the HKD bond market has grown five-fold in scale over the past 20 years, to reach HK$2.3 trillion ($295 billion). Last year, excluding HK Treasury bills, the market saw HK$220 billion in gross issuance, of which 47% were corporate bonds and 53% were government and quasi-sovereign bonds.
This mix is welcome, given the overall dominance of corporate bonds (72%) in relation to sovereign and quasi sovereign bonds. Hong Kong and mainland Chinese issuers account for two-thirds of the total, comprising mainly banks, real estate developers and utilities, along with quasi-sovereign and supranational names from various regions.
The investor base remains mostly localised, too, given that Hong Kong-based pension funds, retirement schemes and life insurers tend to buy most of this debt, based largely on its risk profile. Yet they are cognisant of potential over-concentration in Hong Kong and mainland China, so are keen to see new issuers to bring diversification.
Challenges remain for HKD bonds
However, there are various hurdles to developing this asset class for institutional investors. Among them, despite the relatively higher yield offered by HKD bonds for a shorter duration when compared to other high grade local currency bonds in Asia – including, for example, Singapore dollar-denominated bonds – they face direct competition from USD products, given the currency peg, and RMB products, given the proximity with China.
Asian US dollar-denominated (USD) bonds, for example, are trading at attractive valuations. Plus, in the current rate environment, their shorter duration, higher valuations and the fundamental robustness of the regional companies compared with other markets is appealing given the theme of economic recovery, according to Leap.
Local investors are indeed incentivised, at the moment, to purchase foreign debt and swap it back to HKD.
“From a local investor’s standpoint, USD investments offer better liquidity, a wider range of country/regions and sectors, and better yields” said Leap. “For international issuers, although the funding cost in HKD may be lower, even after the currency is hedged back to their home currency, borrowers can still tap into a wider pool of investors by issuing in USD.”
Another challenge for the HKD bond market, meanwhile, is the lack of diversification – not only in terms of holders who are mainly buy-and-hold investors from insurance firms and pension funds, but also in terms of offering as the countries and sectors of HKD bonds are very concentrated. In addition, most of the non-sovereign HKD deals are in the form of private placements, with poor secondary market liquidity.
The limited valuation granularity in maturities and ratings, plus the lack of a sovereign and swap curve beyond 15 years, stem from these drawbacks.
Addressing issues and driving a new direction for HKD bonds
The fact that asset owners are so selective makes it imperative for the financial sector in general to pursue ways to help the HKD bond market evolve to the next level.
Leap said he would propose several steps. First, with the currency swap currently in favour of local and foreign issuers, funding in HKD should be more widely promoted. He also said large, public issuances would benefit the asset class, rather than private placements.
At the same time, the HKD swap and government curves need to be extended to “longer maturity tenors, such as 30 years”, he added. In line with this, he said it has been encouraging to see some local companies start to move beyond 15 years in some of their more recent HKD bond issuances.\
In the meantime, a potential route for investors to consider regular, relatively stable and reliable income is accessing HKD bonds via the ABF Hong Kong Bond Index Fund. Hong Kong institutional investors may also use this vehicle for their asset-liability matching exercises in HKD. (Asset-liability matching in HKD was among the key take-aways from an exclusive survey in late 2019 by AsianInvestor and HSBC Asset Management).
Greater potential for green issuance
Plugging some of these gaps would also make it more viable to increase issuance of HKD green bonds by Hong Kong domiciled issuers.
To date, issuers committed to sustainability considerations and projects have mostly opted for USD bonds. This mirrors global trends in this space, where 87% of green bonds are in hard currencies.
Leap said there is some momentum in HKD green bonds. “Issuance total for the HKD green bond market hit around HK$30 billion for the years 2017 through 2019, with each year seeing an increase in volume.”
More broadly to bolster the HKD bond market, Leap said he sees reasons for optimism in the coming months over fund flows into more defensive plays such as HKD bonds.
“A lot of money from mainland Chinese investors has been chasing Hong Kong stocks in early 2021, so there is a growing possibility that this will soon start to shift to high-quality bonds,” he explained.
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