HKMA puts out $1bn-plus bond fund mandate

The Hong Kong Monetary Authority has issued RFPs to an undisclosed number of fund management companies to bid for over $1 billion of Asian fixed-income mandates. This comprises the long-awaited Asian Bond Fund 2, an initiative of the region's central banks to stimulate local bond market development.

Mercer Investment Consulting is assisting the HKMA with manager selection and review. Mercer and HKMA officials declined to comment.

The first Asian Bond Fund (ABF1) was launched in 2003 to invest central bank foreign reserves in $1 billion of US dollar-denominated securities from Asian issuers, and was managed passively by the Bank of International Settlements.

That deal was coordinated by the Monetary Authority of Singapore on behalf of the EMEAP - the Executives' Meeting of East Asian and Pacific Central Banks and Monetary Authorities, which includes Australia, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, the Philippines, Singapore and Thailand. ABF1 invested in an index of US dollar bonds from all of those markets except Australia, Japan and New Zealand.

ABF1 was a first step at regional cooperation among monetary authorities, a means to develop the idea of a pan-Asian bond market and a cushion against currency speculators.

ABF2 will invest only in local currency issues, which makes it a far more challenging and ambitious venture. Fund managers bidding for mandates say that, unlike ABF1, this new fund is meant to eventually attract private investors as well.

ABF2 is expected to involve several mandates, both country-specific and pan-Asian, although fund managers do not know which countries will be on the list. They also do not know what kind of pan-Asian benchmark the EMEAP will use; it may be customized to match the investment sizes from the various central banks.

But the idea is to provide not just more demand for Asian bonds - because there already exists plenty from domestic institutions - but a variety of demand. Many domestic bond market issues are snapped up by overlarge pension funds and insurance companies that buy and hold; it is hoped ABF2 will stimulate a secondary market, as well as convince more domestic companies to issue more. Central banks' initial investment into ABF2 is also expected to be larger than they put into ABF1, although the total amount hasn't been disclosed.

The second ABF has been on the agenda of the central banks for 10 months, but the HKMA, which is coordinating the effort on EMEAP's behalf, issued RFPs with an unexpectedly tight deadline. The RFPs went out at the beginning of November and gave fund managers just two weeks to respond, to be followed by a two-week due diligence process.

This has led to speculation that the HKMA or EMEAP is keen to launch the fund very soon, and may in fact be rushing to make up for lost time. The issues involved in launching a pan-Asian local currency fund are thorny and have preoccupied EMEAP all year.

One problem is a potential conflict of interest for policymakers to also act as local investors. Fund managers say the HKMA and EMEAP have remained silent on how they intend to resolve this.

Other problems are more practical. The biggest is the diversity of tax treatments for bond investors across markets. Although fund managers say the region needs to harmonize these if it wants to be serious about promoting Asian fixed income, they note that for now it is politically impossible to achieve, as it directly impacts fiscal policies. The result is that investors will have to pay a variety of taxes, which will hurt the ABF2's performance.

The HKMA has left it open to fund managers to pitch ideas about how to structure the fund. It has also remained silent on the fees it expects to pay, although fund managers acknowledge that this is a prestige project so fees will be low.

The EMEAP favours passive mandates, and it is expected to hire passive specialists such as Barclays Global Investors or State Street Global Advisors. But the lack of liquidity in most Asian bond markets means that a purely passive approach won't be as efficient as it was with the US dollar version.

The HKMA is therefore accepting bids from active bond fund managers to see what kind of value they can add, and how they can use tactics in handling duration or currency exposure to optimize a pan-Asian bond benchmark.