* Asset managers seek returns in local currency
* Growing liquidity makes investment more attractive
* Bankers say corporate bonds are the next target
By Christopher Langner
Feb 25 (IFR) - Credit investors are turning to local
currency corporate bonds to generate better returns after a
prolonged rally in US-dollar debt left little upside.
Michael Gomez, co-chief investment officer at Pimco, manager
of the world's biggest bond fund, has written that local
emerging markets "stand out as continuing to offer significant
value" relative to alternatives from the developed world.
Gomez said EM debt denominated in US dollars now looked
"either just fair or rich versus
other comparable credit alternatives" and that "it is hard to
find a 10-year maturity investment-grade bond where credit
quality is still on an improving trajectory that pays 4.5%".
His comments in an article, titled "The Year Past, The Year
Ahead", were published on the Pimco website.
Pimco is not alone in targeting local markets. Fund flows
suggest other investors are thinking along the same lines. EM
local currency funds have taken in a cumulative net inflow of
US$5.7bn this year, until mid-February, according to EPFR
Global. That is five times more than the allocations to EM
hard-currency bond funds in the same period.
"All the big guys have been paying more attention to Asian
local corporate markets," said Vishal Goenka, head of local
credit markets trading for Asia at Deutsche Bank in Singapore.
Betting on local currency bonds is nothing new to the
world's largest asset managers - and the gamble has mostly paid
off. In 2005, BlueBay set up its EM local currency bond fund.
That fund has returned 68.44% since January 2009 and 18.5% since
January 2012. This compares with returns of 47.2% on Merrill
Lynch's dollar-denominated EM sovereign bond index since January
2009 and 11.5% since last year.
Pimco and Western Asset Management (Wamco) both have funds
dedicated to EM local government bonds. Ashmore has been touting
the benefits of the asset class since 1997, when it launched its
local currency debt portfolio.
In its 2013 outlook, Ashmore renewed its pitch for EM local
currency bonds. "Local currency government bonds pay nearly
500bp more than equivalent-duration US Government bonds.
Correlation with US Treasuries is very low, and volatility of
yields is lower. The universe is 90% investment grade and set to
reach a size of US$20trn at the end of this decade."
While global funds have long invested in local currency
debt, they have largely stayed away from local corporate bonds,
preferring less risky government securities. Local regulations
and taxes have also been a hurdle: countries like India, Brazil
and even Single A rated South Korea have used limits and taxes
on foreign money as a currency-control tool several times in the
past five years.
Corporate bonds can be risky investments, but the growing
liquidity in the world's local currency markets - offering the
possibility of an easier exit - is tempting global asset
managers to overcome their fears.
Deutsche's Goenka pointed to the rapid growth in some major
Asian markets as proof that they had become more liquid and,
hence, a tad safer. He estimated that the South Korean corporate
bond market had some US$777bn equivalent outstanding as of
October, with China close behind at US$650bn, Malaysia US$118bn,
Singapore US$120bn and India US$200bn.
According to Thomson Reuters data, corporate bond issues
last year totalled US$440bn in Asia, excluding Japan and
Australia - almost four times as much as the amount companies
raised in dollar-denominated debt in the region. More bonds mean
In its latest quarterly bond market report in November, the
Asia Development Bank also noted the liquidity improvement.
"Bid-ask spreads for both government and corporate bonds
tightened in most markets in 2012, while average trading sizes
Yet, according to the ADB, the average transaction size in
the secondary bond market is just US$9m in South Korea, US$7m in
China,US$2m in India, US$1.1m in Singapore and Thailand,
US$600,000 in Indonesia and US$500,000 in the Philippines. That
is still far short of the sizes the biggest global fund managers
are looking to trade.
Nevertheless, at a time of ultra-low dollar yields, the high
returns local corporates bonds offer may have become too hard to
pass up. According to Goenka, the average blue-chip corporate
bond in India returns some 125bp over government-securities,
which themselves already have nominal yields more than 550bp
higher than US Treasuries.
As Pimco's Gomez wrote: "While negative real rates out to 10
years are an unfortunate reality for many developed world
sovereign debt investors, most EM local markets continue to
operate with positive real policy rates and provide investors
the opportunity for attractive carry and roll down further out