Asset owner survey: turning more cautious on HKD bonds
Amid lingering doubts over global economic growth and geopolitical stability in 2020, certain Asia-based asset owners continue to derive various benefits from holding Hong Kong dollar (HKD) bonds.
The biggest drawcards – mostly for locally-based insurance companies – include asset-liability matching, investing with low (or perhaps nil) currency risk, and accessing high-quality issuers.
This was among the key take-aways from an exclusive survey conducted in November and December 2019 by AsianInvestor and HSBC Global Asset Management of around 100 institutional investors in Hong Kong, plus some other Asian markets.
In fact, in an equivalent survey by AsianInvestor and HSBC Global Asset Management (HSBC AMG) in mid-2017, asset owners also pinpointed asset-liability matching requirements and low currency risk as catalysts for them to buy HKD bonds.
Appetite for HKD debt has the potential to grow even further, too – but only if some of the key issues that investors highlighted in the survey as their main concerns with the asset class can be addressed. These include:
- The relatively lower yield and returns of HKD bonds (37% of respondents)
- The limited choices of HKD bonds available in the market (34%)
- The credit outlook for HKD assets (16%)
This was again broadly similar to results from the 2017 survey. The main improvements that participants said they wanted to see in the HKD bond market at that time were: a broader credit universe with a higher number of corporate issuers (43% of respondents); increased liquidity (21.4%); and more public deals rather than private placements (18.8%).
Despite such continued shortcomings as yield, liquidity, choice and availability, pricing levels could spur allocations, given the currently higher interest rates in Hong Kong relative to US dollars, according to Cecilia Chan, chief investment officer fixed income for HSBC AMG in Asia-Pacific. “With the HKD swap curve trading higher than its US dollar equivalent, currently there is a yield-pick up from investing in HKD bonds, especially at the short end of the curve.”
Yet since this trend is at the mercy of market sentiment, asset owners are turning more cautious and seem to increasingly be looking for more fundamental developments in HKD bonds to drive allocations before committing to the asset. For example, in the latest survey, 16% of respondents – mostly insurance companies – said they plan to increase exposure over the next 12 months, compared with 42% in mid-2017, representing a drop of 26% between the two years.
Across the different types of investors who responded to the survey, insurers and endowments comprised the largest group, at 16% each, followed by sovereign wealth funds and pension funds, accounting for 11% each. Other respondents include corporations, hedge funds, family offices and other asset owners. It is notable that insurance companies were among the main contributors to the survey given that these institutions, especially those with Hong Kong operations, are in most need of assets that help them meet their asset-liability matching requirements.
A careful watch on 2020
The widespread uncertainty among investors more broadly over the outlook for growth and inflation might also stem fund flows into the asset class for the time being.
The results to the survey’s opening questions – which covered the macro environment before focusing on HKD bonds – reinforce this sentiment. Although about a quarter of the asset owners who responded said they expect growth to surpass 3% over the next 12 months, 61% of them forecast it to hover in the range of 1% to 3%. The rest were even more pessimistic.
This relative caution is reflected in the top three concerns among respondents for 2020:
- Global economic slowdown, at 37%
- Geopolitical instability globally, at 34%
- Continued trade tensions, at 18%
In terms of inflation, nearly two-thirds predicted it either to be between 1% and 2% (35% of respondents), or from 2% to 3% (30%).
This might partially explain the concern among some other investors (6%) that a worry for the year is policy disappointment in relation to the US Federal Reserve under-delivering on expected monetary easing.
With such consensus over the investment landscape, it is to be expected that 69% of respondents said they will either increase their allocation to fixed income (40%) or keep it unchanged (29%) in 2020. Cash, or cash-type instruments, as well as alternatives, are two other broad asset classes to which portfolios will increase allocations over the next 12 months.
Playing the proxy
This comes on the back of a positive 2019 for capital gains in Asian fixed income. This year, however, Chan said geopolitical risk might overshadow the relatively supportive macro landscape for fixed income. Plus, a more stable, sideways-moving environment for interest rates and growth is likely.
“Asian fixed income will be more about credit selection and the yield-carry story in 2020, rather than capital gain,” she explains.
Against this backdrop, HKD bonds might be more of a proxy, as an alternative for Hong Kong-based asset owners to HKD deposits. “They will benefit from a macro environment which supportive for bonds,” adds Chan.
Even in the current market environment, Asia-based asset owners who responded to the survey seem most interested in adding fixed income exposure to local currency bonds denominated in US dollars during 2020. In the local currency space, global emerging markets and Asian debt are sought after.
The results also showed much higher demand for US dollar-denominated credit bonds, in particular for both global and Asian investment grade paper.
By comparison, in the 2017 survey, about 54% of participants said they would raise their allocation to Asian fixed income on top of investments in HKD bonds in the following one to three years; 55% of them expressed interest in US dollar-denominated Asian credits but not Asian local currency bonds.
More specifically for HKD bonds, in the latest survey, more than half of the asset owners said they will either increase their exposure over the next 12 months (16%) or maintain their existing allocation (38%). Only 19% said they will reduce exposure.
Taking a step forward
To support the development of the HKD bond market, meanwhile, a broader credit universe via more corporate issuers is high on the wish-list of just over 50% of respondents – especially insurance companies with Hong Kong businesses. This was similar to the research findings in 2017.
Other important market drivers in high demand among asset owners today include:
- More liquidity in the HKD bond market (25%)
- More HKD bonds market-makers (19%)
“More attractive pricing is another important factor in encouraging more investors to look more seriously at HKD bonds,” adds Chan.
Notably in line with the overall survey findings, it seems that the low risk, stable return, highly liquid nature of this portfolio tool still holds a valuable place in the allocation plans of those investors looking to both ride out volatility and meet specific risk management and hedging needs. Certainly, the defensive element of this asset class fits well with the shifting demographics of Hong Kong’s population.
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