* Local funds buy dollar bonds amid lack of options
* High-grade pipeline grows despite expected drop
* Dollar rise moves derivatives in favour of swapping
By Christopher Langner and Kit Yin Boey
April 4 (IFR) - High-grade investors in Asia are facing potentially very few gains as the value of the bonds they hold is likely to drop soon on the back of an expected rise in US Treasury yields. "We have been warning investors for the past few weeks to sell investment-grade," said a sell-side analyst in Singapore.
In spite of that, seven investment-grade deals surfaced in the first three days of this week, suggesting bankers believe there is still plenty of demand for the asset class. They have some support for that in secondary markets as there is yet to be any sell-off.
However, bankers seem to be seeing a source of demand that may have gone unnoticed to others. One portfolio manager in Singapore noted that as the dollar has gained against other currencies, including the Asian ones, it has also moved the cross-currency basis swaps locally.
This has made the economics of buying dollar-denominated bonds and using derivatives to swap them into local currencies and interest rates more compelling for investors in some Asian countries.
The shift comes at a time when the amount local funds have to invest is increasing faster than the amount of assets available for them to invest in, especially on the fixed income side.
South Korea is one example. The cross-currency swap from the Korean won to US dollars is hovering around -100bp. Since mid-July the derivative was below -110bp, having spent much of the second half of 2012 around -150bp.
The closer to zero, the more advantageous the conditions are for investors when they swap the bonds into their own currencies.
For a graphic of the five-year Korean won/US dollar cross currency basis swap please click here: reut.rs/XYXIxW
At the same time, according to data from the Korean Financial Investment Association, assets under management of local funds have grown 10.6% in the past 12 months to W335.6trn (US$298.8bn).
In the same period, the amount invested in derivatives - which includes cross currency basis swaps - has grown 46.8% to W33trn. No surprise that three of the investment-grade deals announced this week were from South Korea.
Perhaps the best indication of the strength of local demand for dollar bonds comes from Thailand. On Tuesday, Thai coal company Banpu became the first domestic issuer to sell US dollar bonds in Thailand's local market. The US$150m 10-year paper priced at 207bp over US Treasuries, or a 1.92% yield.
Traditionally, Thai investors have not been big buyers of US dollar paper, but the supply of baht-denominated bonds has not kept pace with growing local liquidity. Cheaper currency swaps are also allowing local investors to access dollar investments without taking additional currency risk.
"There will be demand for onshore US dollar bonds," said a banker away from the deal. "Investors, such as insurance companies and asset managers, are still keen on buying US dollar bonds."
Total assets under management in Thailand amounted to Bt2.82trn (US$96bn) as of March 15 2013, Bt206bn more than at the end of December 2012, according to data from the Association of Investment Management Companies. Thomson Reuters data shows that Bt154.6bn of bonds were issued from January 1 to March 21 this year, as issuers tapped into the growing demand.
Investors can swap dollar products back into baht because of the significant improvement in the baht/dollar basis swaps, now around -30bp, versus -140bp a year ago. A Bangkok-based trader said the huge flow of foreign funds into Thai government bonds had helped to push basis swaps tighter.
Besides the better conditions for asset-swapping the bonds, the homegrown demand for offshore bonds may also be driven by accounts that do not want to swap the bonds back.
As the dollar rises, many just want to park their money into assets denominated in that currency. "With the United States data improving, local accounts have the inclination to go long the dollar," said a portfolio manager in Singapore.
The bottom line is that in spite of all the headwinds, there will be plenty of demand for upcoming dollar deals in the investment-grade space, even if it comes right from same country as the issuer but in a different currency. (Reporting By Christopher Langner and Kit Yin Boey; editing by Nachum Kaplan)