Korean issuers become developed
* Global funds allocate Korea to developed portfolios
* Korean bonds outperform peers in Asia
* Spreads becoming too tight for EM investors
By Christopher Langner
SINGAPORE, Oct 7 (IFR) - South Korea's position as a developed market is being taken more seriously by fixed income investors who, rather than place them in emerging markets buckets, are increasingly allocating bonds to developed markets portfolios.
"I have been asking the big asset managers specifically for which portfolio they are buying these bonds and I have been told by a few that it is going to their developed markets funds," said one banker involved in recent dollar bond sales of South Korean corporations.
Managers of Asian portfolios for some of the world's biggest asset-managers admitted that the profile of buyers of South Korean debt has changed. "There is a lot more participation of US investment-grade funds and insurers in these bonds," said an Asia-based portfolio manager for a large Western institutional investor.
The shift is significant as it suggests South Korean issuers can expect much broader demand for their bonds and they can expect to pay potentially much lower spreads. Bankers said this explains why South Korean issuers sold near-record amounts of debt in the offshore market in the past five weeks, but their bonds still performed fairly well.
It also would explain the relative performance of most Korean dollar bonds during the summer sell-off, when they outperformed other similarly rated bonds from Asia.
Indeed since December, Korean bonds have shown a higher correlation to US investment-grade indices than to Asian ones. The five-year bonds of the Export-Import Bank of Korea, Kexim (Aa3/A+/AA-), issued in February are probably a good example of that.
That bond dropped 2.63% between May 14 and July 31, a period of high volatility for investment-grade bonds because of fears that the Federal Reserve would reduce its monetary stimulus. The drop was in line with US high-grade bonds of the same category. Meanwhile, the JP Morgan GBI Asia index dropped 3.5% in the same period.
Another measure of how South Korea is now being bundled up differently is in the performance of its credit default swaps. Since November 2012, the sovereign's five-year CDS have had more and longer periods of positive correlation with the US CDX index than in any prior period in history.
Also, in December, the correlation between Korean CDS and the Asia iTraxx IG ex-Japan index was briefly negative for the first time. Since then the correlation has been mostly positive but the 89-day moving average of the correlation, which historically remained above 80% this year, most of the time remained below 70%.
MORE DEMAND FOR THE SUPPLY
South Korea has become a safe-haven play with minimal headline risk and issuers from the nation already have sold more than US$15.6bn in dollars, yens and euros this year.
"Outside of Korea, most markets (in the region) have been lacklustre, there is macro risk everywhere, so everyone is parking in Korea," said one credit strategist for an institutional investor.
Korean bonds, which usually are rated in the high Single A category, yield more compared to similarly rated bonds in similar sectors in the US and Central Europe. This makes the country an attractive proposition for any fund looking to improve returns without going down the credit spectrum.
The trouble, however, is that traditional buyers of South Korean debt, who follow the JP Morgan EM Bond Index, are finding Korean bonds too expensive. "US investment-grade funds have much lower return benchmarks so for them it looks like cheap debt for the rating," the portfolio manager said.
"They can outbid the average [JP Morgan Asian Credit Index] and you get priced out," he added saying that he did not participate in most of the recent deals because final pricing came below his required threshold. (Reporting By Christopher Langner)
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