The Peregrine mafia: volume one

In its heyday, Peregrine played a pioneering role in the growth of the Asian debt markets. Damien Wood was one of its star analysts. Today he is head of fixed income research at ING Barings.

Do you look at both high yield and high grade? Or do you tend to be more focused one or the other?
The skew is on high yield rather than high grade. We are trying to look at credits where we can add value, where people will take the time to look at our research - whereas if we wrote about MTR it doesn't really matter if we write the world's best report, because what people want to know there is the sovereign view. The same thing with Petronas. What we try to focus on is a case where the underlying fundamentals of the company matter to the bond investor, and try and focus on those types of bonds.

If you have a good idea about a high yield bond, what is the best way of disseminating it?
We won't just say that looks cheap, and recommend 'buy'. Our process has evolved over the past 12 months, in building the team. We will look at a range of about 40 credits and try to understand them very well. We will try and meet with the management, meet with the competitors and try and get an idea of how they are situated within the local economy or industry. The second step is looking at the valuation of the bonds compared to its peers and risk assets and calibrate the risk return over the next 12 months. And if a bond, for some reason, looks very cheap, and if we think the credit spreads are going to contract, we'll disseminate that idea through our monthly product. If we think something is of particular interest we'll highlight it as a top recommendation. If an event is happening that people have to act on straightaway, we'll do it through a Bloomberg, which goes out to all our customers. That's more of a timing thing, for example when we knew that the Hynix events were about to unfold, again, through the Korean press, and we got a Bloomberg out very quickly. That was very helpful to some customers and our salespeople. But really we try to revolve around fundamental analysis and risk return.

So you don't have an idea and call 15 accounts?
We would never do that before we have put the research out - for compliance reasons. It's also an ethical thing. I don't want to favour certain accounts. I want to throw this opinion out via Bloomberg or whatever, and then ring up the accounts I think would be interested. I'd never do it the other way around.

So what have been the greatest calls this year?
Our best call was GH Water. Others will talk about that. One thing we can say is we believe we were one of the first to put out a research report on that credit and certainly the most in-depth one in the market. Our utilities analyst pored through the 100 plus pages of documentation over December and took the view that it is not really China BB risk but Hong Kong BBB risk, because of the way the cashflows work. And so far that has proven to be pretty accurate. We are still pretty comfortable with the bond even now. It has moved from the mid-60s to 89, and we still see a lot of potential in that bond.

Has GH Water been the best performer in Asia this year?
Of any performing bond, yes.

Any other good calls?
It has mainly been the China calls, such as Road King and GS Superhighway. If you looked 12 months ago at which was the best performing economy in the region, you picked China and saw there was some very high yielding bonds there. We went through them in quite a bit of detail. In the case of GS Superhighway, we went out to the road itself, checked that it looked okay and talked to people that used it, the manager, understanding why it existed. We got to know the management of Road King very well to make sure nothing was hidden, especially given the uncertainty with Chinese issuers, and the fact that information can be not that accurate. So we went out of our way to find out about these companies and thought investors are getting great value here. They will benefit from China being a strong performer and from high yield.
Over the last 12 months we have been pretty strong as well on Korean bank subordinated debt - Hanvit, Cho Hung and KEB - and have been since they were issued. We changed to a hold recommendation when KEB went to 108.
We've liked PLDT in the Philippines but it has performed badly. That's probably the one bond we think is okay and we're sticking with, but has been a disappointment from a performance perspective. But we think that bond will come back.

On the high yield side, how important, for example, is it to have led the bond for Cho Hung? Does that give you an advantage, because you know where the bonds are placed?
It is from a valuation perspective, although not from a credit fundamentals one. It helps to know the psychology of the investor, and that's why it is becoming increasingly difficult for the Korean subs, because more and more Koreans are punting them. They seem to punt them for reasons which a US investment fund would not punt them.
If certain events happen which are fundamentally negative or positive, you know on average how a US investor will react. But with the Koreans it appears totally random. And that's what is getting more difficult.
But I agree, knowing what makes the investor base tick is very important. And if you don't know who the investors are, it is more difficult. We encourage our analysts to understand who buys and sells the bonds. You can't do that with a balance sheet. You have to talk to clients, and figure out how they feel that day.

Have you had any of these conversations with Korean investors to try and understand their psychology?
I have a few, but it hasn't been very fruitful.

A key theme talking to your counterparts is that it is almost a misnomer to talk about Asian credit research, because so much of what you do is about understanding technicals. Do you agree?
I disagree. We go through the fundamental analysis and say this bond looks cheap. And we say why. We go to investors and go through our thinking in a great deal of detail. Some of them come in and buy.

But the Korean situation is not driven by fundamentals.
Their investment process is not. But there are still a lot of bonds held by people whose decisions are still based on fundamentals.
How do you explain the 130bp spread differential between Malaysia and Korea?
That is the technicality of the local Koreans buying the bond. And with high grade Korean credits, fundamental credit research doesn't matter much. So I would agree that the Korean market is somewhat distorted. But a lot of bonds such Tenaga move on a fundamental basis.

How do you deal with situations where you are talking to highly sophisticated investors and they say "I'd love to buy this, but the way these bonds trade defies fundamentals". Your research is very rational, but these bonds don't trade rationally.
As in with Korea? Yes. That is the hardest part, and we have to say that in the long run the fundamentals will win. I suppose a classically-trained investor will agree with that.

Do you think this whole Asian bid is a long term phenomenon or is it going to go away?
It's a fairly long term phenomenon. It is based on local investors suffering from poorly performing equity and property markets. They've traditionally been big investors there, but have been beaten up year after year. Now they have put the money into banks, and the banks are going into bonds. The excess liquidity in the market will remain while deposit rates remain low, and while equity and property markets remain poor. When that turns around, whether tomorrow or 10 years, then they will start to move money back into those assets. That's when the Asian bid will return to where it was pre-1997.
Right now we estimate there is $850 billion of surplus liquidity in Asian banks. Just a fraction of that coming into the bond market will keep bidding it up.

Do you think the quality of Asian fixed income research has gone up since the crisis?
I think so. The maturity of the market for one thing has gone up, secondly analysts learnt some lessons the hard way. And investors also started to demand it.

Is it up to the quality of US credit research yet?
Some of it is. Also it is a little bit more difficult in Asia because the information is not so accessible, or as accurate. But I'd say while the US might on average be better, the gap has narrowed. I'd say a third of Asian research is up there with the best from the US. And from what I've read of the European stuff, it is actually better than that.

So you think there are three or four heads of fixed income research around Asia who could immediately be transferred to the same job in New York?
For sure.

Looking back at your experience at Peregrine, what did you learn from that which makes you better at your job today?
I suppose I've taken the aggressive culture of trying to get things done. Peregrine was the biggest creator of the bond market - it went bust doing it, as often pioneers do. So I took the culture of getting things done, even if they haven't been done before.
As an analyst, I didn't bring that much away. Although I did learn from the Indonesian situation. Now I realize that if you understood your history you could have seen it happen, especially in relation to the social unrest and the ethnic Chinese. If I had had a better understanding of history, I could have identified why the rupiah could have gone to 16,000.

Do you think there is scope for another Asian fixed income house like Peregrine?
There is scope. They led the pack because they were the first movers but also the most aggressive movers. It would be a lot harder to do it. But if someone was willing to invest several years of capital and people and get the right leader, it can be done.

How much of the business is now about selling bonds to private banking clients?
We're seeing a sea change from a few years ago. A lot of the tickets now are small tickets to individual private banking investors, who I would guess are getting out of property and equity. The interesting thing if you speak to Citibank Private Bank or HSBC Republic or even our private bank, is that a lot of these new bond issues, a big proportion are going to private clients, which was previously unheard of.

Would private clients buy GH Water and if so, why?
It's a simple story, that private clients could understand. Hong Kong needs water every day. There are no alternative sources. So if there is water coming out of the tap in your apartment, you know the bonds are being serviced. It is really as simple as that. The Hong Kong government has to buy the water, these funds get trapped in Hong Kong in a trust at Standard Chartered and paid to bondholders.

What does this trend mean for liquidity?
Private clients tend not to trade as much as institutional investors and will sit on bonds. So it might damage liquidity as they become a bigger and bigger part of the market. But it is not at the stage where it is a problem yet.