Wealthy Asian investors are driving a boom year for bond offerings from Asia, typically an equity-dominated region. However, are private clients here to stay?
Source: Reuters/David Gray
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When Hong Kong developer Nan Fung International launched a 5.25% five-year bond in January, even the bankers working on the deal were surprised to see a full 51% of the order book made up of private banks.
The deals that followed quickly showed that was no fluke. The likes of NWS Holdings also enjoyed a similar reception, while Henderson Land drew 50% of orders, a month later, from private wealth managers, despite paying a coupon of less than 5%.
Just five years ago, the idea of marketing such low-yielding bonds to Asia’s private banks would have seemed ludicrous. Back in 2006–07, the global economy was growing quickly, and Asia’s individual investors were firmly focused on equity markets. The few high-net-worth individuals, who did stray into fixed-income, were interested only in double-digit coupons.
Recent new issues show Asian individuals are embracing bonds like never before. In an emerging region, where wealth creation is still running high, that has big implications for the primary markets.
“We’ve seen a significant asset-allocation shift towards fixed income. The lower volatility, relative to the equity markets, and the decent performance of new issues, are driving investors to the credit space,” said Adam Tejpaul, head of investments at JP Morgan Private Bank Asia.
Asian wealth is far from a new phenomenon and many of the most sophisticated individuals have taken exposure to bonds for years, but the scale of participation has changed dramatically since the end of 2011.
Five years ago, Asia’s typical high-net-worth individual had very little exposure to fixed income. Numbers varied across the region – Indian clients, for instance, have typically banked more bonds than Chinese – but advisers say an allocation of 0%–5% was not unusual. Today, those same clients may have 20%–30% of their portfolios in bonds.
“Allocations to fixed income have been very strong over the last seven or eight months,” said Elaine Ngim, head of fixed-income research for Asia at Coutts, a unit of RBS. “Asian investors are traditionally geared towards growth valuations. As the European crisis has mitigated the global growth outlook, investors have been shifting their attention to stable cash flows.”
Higher-yielding assets prove the most popular. A full 70% of orders for Shui On Development Holdings’ 9.75% three-year bond, issued in February, came from private banks – a response that Indonesian developer Alam Sutera matched a month later on a 10.75% five-year.
Even low-yielding and long-dated bonds drew a strong response from the wealth management industry. An unusually high 9% of orders for Thai oil company PTTEP’s 30-year 6.35% bonds came from private banks, while bankers even reported private-bank interest in 10- and 30-year deals from Triple A rated Temasek Holdings in mid-July.
Private bankers argue that the surge in interest is a consequence of the growing market – not necessarily a cause.
“Asia’s fixed-income markets have only grown to a reasonable size in recent years. The breadth of instruments has made more investments available,” said Kelvin Tay, chief investment officer for Southern Asia Pacific at UBS Wealth Management.
“Asia’s fixed-income markets have grown significantly in recent years, enlarging the breadth and depth of the market substantially and, thereby, making it more accessible to investors. Also, Asian retail investors are becoming more sophisticated, and they recognise that some investment-grade exposure can be a good part of a balanced Asian portfolio.”
Ngim at Coutts agrees. “Increased issuance from Asian corporates has been another factor. We’ve seen more US dollar issues out of Asia and some familiar names coming to market. At the same time, greater transparency and political stability is giving people the confidence to invest.”
Asia’s bond markets are enjoying a quantum shift as bank deleveraging and low Treasury yields drive more companies into the capital markets. With Basel rules looming, that trend looks unlikely to be reversed, meaning supply will continue to grow.
“After the Lehman collapse, companies have been trying to diversify their funding sources and lengthen maturities,” said Peter Lee, head of fixed income for Asia at Societe General Private Bank. “At the same time, low default rates create a mismatch in pricing that has been quite attractive.”
On the demand side, the surge in fixed-income allocations can also be traced back to the fallout from the Lehman Brothers collapse in 2008. Capital losses on equities and structured products have prompted many investors to search for a safer, more stable alternative.
“Private clients used to like the consensus trade in equities. Now, they have no confidence – even when stocks look cheap, people know they can easily go down another 40%,” said Muska Chiu, senior vice president, fixed income, Citibank Private Bank.
“People have experienced a bond market rally in the last few years, and that experience doesn’t go away. After the Lehman collapse, the fixed-income market allowed people to recover their losses within one or two years and is far less aggressive.”
Corporate earnings and economic growth are also part of the equation.
“The catalyst for Hong Kong corporations was the belief that the loan market would be constrained through 2012, which prompted companies very reliant on loans to diversify. That coincided with a slow end to 2011 for the general investor base, which created very positive supply and demand dynamics,” said Stephen Williams, head of debt capital markets for Asia Pacific at HSBC.
Dumb money?
Back in the 2006-07 credit bubble, private banks were often regarded as the investors of last resort – the only buyers of an otherwise unsellable bond. Syndicate bankers privately joked that offering a 50bp rebate would fill any book within hours, suggesting that wealth managers spent considerably less time doing credit analysis than their institutional clients.
Just as in the IPO markets, private clients were notorious for flipping out of new issues within days, booking their leveraged gains and moving on. Companies preferred to allocate bonds to institutional investors, seen as longer-term holders.
That attitude still lingers in some quarters, but private banks are finding that their clients are becoming smarter bond buyers as their experience builds. It is not unusual for a wealthy Asian family to have four or five private bankers, and that competition is adding new depth to research coverage across the credit markets.
“The knowledge base has gone up, because of the increased exposure to fixed income. Family offices are now very sophisticated,” said Ngim.
The new degree of sophistication is making Asia’s wealth-management industry a testing ground for new products. Hong Kong and Singapore were essential roadshow stops on Basel III-compliant perpetual bonds for Banco do Brasil and Russia’s VTB, as they were for earlier loss-absorbing contingent convertible deals from the likes of Credit Suisse and Standard Chartered.
Cynics argue that yield-chasing private investors are taking on risks they do not fully understand, especially with the arrival of increasingly complex transactions, such as perpetual hybrids.
Regulators across Asia, under fire for allowing Lehman-linked structured notes to get into the hands of elderly savers, are already looking into the selling of perpetual bonds after a spike in issues early this year – sometimes through a system as simple as an ATM.
“The average client is now very well versed in fixed income – including CoCos, hybrids and so on. For the more complex products, you need to spend hours with the client before they make any allocation – and that knowledge will stay with them for the long run,” said JP Morgan’s Tejpaul.
“There is a high interest in yield, and that’s not necessarily a good thing. There’s a very big difference from one deal to the next, with call features and loss absorption, for instance. Investors need to be extraordinarily selective.”
Distorting prices
Private-bank money may be getting smarter, but the sheer volume can still have a big impact on deals. New issues are all important in Asia’s credit markets, since bonds are harder to obtain in the thinly traded secondary market – and bid/offer spreads often wide. As a result, demand for fixed income has powered order books to heady oversubscriptions, allowing issuers to push for lower yields.
“Private banks in Hong Kong and Singapore have been getting very aggressive, and that has led to very big order books and helped some deals get very tight pricing. Those deals have still performed, though, so the oversubscriptions have not been a problem,” said Williams at HSBC.
The strong performance of this year’s batch of new issues has only added to investors’ enthusiasm for further debt sales. Some, however, believe the first-half rally has already taken a lot of potential value off the table.
“New issues are becoming crowded, and we don’t think it’s worth chasing every deal. High-grade and high-yield are both heading towards where we see fair value, and we are looking for other opportunities for our clients,” said Tejpaul, pointing to rising demand for distressed credit, even mezzanine debt.
Institutional investors also blamed overaggressive private banks for allowing companies like Nan Fung to tap their newly issued bonds earlier this year. The additional supply – often coming only weeks after the original deal – limited potential gains on the existing bonds.
The rebates offered to encourage private banks to focus on a new issue only add to the institutional fund manager’s annoyance. There is no sign that the practice is about to disappear, but even some wealth managers argue that the practice is outdated.
“In 2005, private banks probably needed an incentive, but that’s not as important now,” said Citigroup’s Chiu. “That said, the rebate does help encourage sales teams where some additional focus is needed, such as for Single B names.”
Wealthy individuals still have access to leverage through their private banks, and many have used that credit to boost their returns on this season’s crop of investment-grade bonds.
While many banks have scaled back their corporate loan books, pushing more Asian companies into the capital markets, those same banks are still happy to provide leverage for private-banking clients when that company comes to the capital markets.
Private banks can offer leverage of up to 80%–85% for an investment-grade instrument from a well-known company, with the exact ratio depending on the rating, maturity, liquidity and the client’s own risk profile. With credit available at low costs, that can easily push returns on a high-grade bond into the double digits.
Private bankers, however, argue that the use of leverage has not changed enough to explain the recent surge in demand.
Here to stay?
“Leverage has always been there, but the factor is how aggressively it is used,” said Ngim at Coutts.
“Credit is cheaper, but that’s not always the determining factor. We always recommend a conservative approach to the use of leverage. Since fixed income are still mainly traded on the OTC market, prices and liquidity are not as transparent, compared to the exchange traded equity market. Prices can gap down very quickly in a disorderly manner, especially in a selloff environment, and that can be very painful for clients if leverage is adopted too aggressively.”
Tay at UBS agrees that leverage is “extremely important in some markets”, but that has not changed.
“It was always available, depending on the rating, liquidity, and so on. That’s not really what’s driving orders,” he said. “The market was previously held back by the lack of quality issues, a factor which has gradually changed over the last two years.”
In the near term, origination bankers see no let-up in the supply of new issues and wealth managers expect demand to stay strong.
“Growth in Asia will be slower and, in many places, inflation remains persistently high. With negative real interest rates, people are looking to preserve capital,” said Lee at SG. “It’s hard to see any radical recovery in the global economy over the next two or three years, and that is driving demand for stable income.”
The real test, however, will come when growth begins to recover and equity markets again look attractive. As investors readjust their portfolios to capture that growth, defensive allocations will suffer, and there is a risk that the private-bank orders will all but disappear.
Wealth managers, however, believe that today’s orders signal a fundamental shift in attitudes – and that is unlikely to be completely reversed.
“The majority of clients are over 50 years old and are focused on preserving their wealth. In the past, when their companies were growing faster, they had more chance of recovering any losses through their own businesses, whereas, today, they are more conservative,” said Chiu.
Tejpaul at JP Morgan sums it up: “Part of it is temporary, but another will be there for the long term. Given how high equity allocations were in Asia, some of that percentage will stick in fixed income even if equity volatility does subside,” he said.
