Investors expand appetite for offshore RMB

Asiamoney, November 2011

Where asset markets grow, mutual funds follow. As the CNH, or dim sum, bond market develops around offshore issues in RMB, an increasingly well-diversified asset management industry is taking shape alongside it.

Hard data is difficult to come by, but Asiamoney is aware of almost 30 separate mutual funds or similar investment structures investing mainly in offshore RMB bonds. Already, there is a market with several clearly defined strategies: some focus on credit, others high grade, while some combine bond exposure with deposits and futures, and still others bolster their portfolios with Asian dollar high yield deals which they swap back into RMB.

At one end of the market are the big international names one would expect to see in any new debt market: HSBC, Schroders, UBS, Barclays. Alongside them are a host of home-grown Hong Kong or Chinese names: Haitong, Hang Seng, Citic, Ping An. Some are on their second or third funds. HSBC already has a US$500 million Cayman-domiciled fund, the HSBC RMB Bond Fund, and has just launched a UCITS-compliant fund domiciled in Luxembourg to broaden the reach to a wider audience, particularly clients in Europe. It is launching an RMB currency fund in North America and will look at other structures too. “It’s fair to say that Hong Kong is the home of the offshore RMB, and the home market of HSBC,” says Geoffrey Lunt, director and senior product specialist for fixed income at HSBC Global Asset Management. “For other fund managers this may be a peripheral activity; for us it’s at the very centre of what we do.”

Any discussion about offshore RMB quickly reaches the subject of the supply and demand imbalance: RMB deposits in Hong Kong reached RMB609 billion at the end of August and have at times routinely grown by 10% per month. The need for these assets to be invested in more yield-producing assets has created an imbalance that has, in the past, allowed some very average credit to raise money at very low rates. But every fund manager spoken to by Asiamoney described a relatively easy time allocating the funds they raise, and getting access to the bonds they want.

“We have not had significant trouble investing that money,” says Lunt of HSBC’s $500 million fund. “We are very happy with the way the market has developed and we’ve been able to cope with a lot of the demand we’ve seen for the product.”

Chris Faddy, Head of Distribution at Barclays Capital Fund Solutions for ex-Japan Asia, says fund managers on Barclays’ Renminbi Bond Fund – launched in Singapore in April – have had no problem getting the securities they prefer. “We are extremely aware of the discussion around liquidity,” he says. “However, our experience has been that we have got a full or 80% allocation of every single primary issue we have participated in. The key to participation is relationships: either the fund managers like ourselves that are part of an investment bank, or those with strong relationships with the key brokers, will get the better access.”

Similarly at Singapore’s Fullerton Asset Management, Patrick Yeo says Fullerton’s offshore RMB fund – with US$245 million under management – “could easily go up to $400 or $500 million” without running into problems with allocation. Again, it’s about relationships, he says. “One of our strengths is that we have pretty good relationships with our counterparts,” he says. “Temasek [which owns Fullerton] is an investor in a lot of the Chinese banks such as Bank of China, which is one of the major players in the CNH market, so if they bring in deals and we participate, we tend to get very good allocation.”

And the many local Chinese players report a similar experience. Ben Rudd is executive director and head of overseas investment at Ping An Asset Management (HK), which has seen its RMB fund climb from RMB205 million at inception to RMB1.55 billion, with precisely one day of net redemptions along the way. “Although competition is quite intense in the new issuance market, based on existing relationships with both Chinese and international banks and our strong brand and team, we are normally able to get a high allocation for our issues in primary deals of 80 to 100% of the desired size,” he says in written responses to questions from Asiamoney.

Getting in at the primary market level is crucial, because demand is pushing the secondary markets to much less appealing levels, where there is liquidity at all. “We can’t be buying on the secondary market all the time – that would reduce yield,” says Faddy at Barclays. “The difference between primary and secondary on an issue could be over 1, 1.5%. We picked up Air Liquide on the primary market; those types of securities are trading 100 points under on the secondary market.” That said, secondary market activity is improving; where average ticket size in secondary trading was around $3-5 million at the end of 2010, it is now more like $10-30 million, Rudd says, and in some cases as high as $75 million, a function of increased issuance and the appearance of new trading desks. “Clearly liquidity has surged dramatically for the last nine months,” he says.

There are three reasons concerns about allocation and liquidity have eased. One is that many funds have been smart about the amount of assets they are prepared to accept. “At no stage did we want to compromise our clients by promising too much capacity to them,” says Lunt. “We have been very careful about the growth of our funds in this area.” Faddy makes the same point: “We have been very deliberate in building our asset base slowly. To actively participate in the primary market we need to make sure we don’t grow our assets too quickly.”

Another reason is that the market has now reached a decent size: just over RMB200 billion at the time of writing. It has become reasonably diversified by industry, credit quality and geography – though not yet really by maturity – and this has made life easier for managers trying to pursue a particular strategy rather than just having to buy assets in order to get something. “It has not been too difficult to diversify the portfolio,” says Rudd. With size has come a certain resilience; Lunt notes how encouraging it was to see two-way pricing maintained in the market throughout the recent global volatility. And there’s little reason to expect supply to fade. “In the last few weeks of market disruptions, this [offshore RMB] was one of the few that was effectively still open,” says Suanjin Tan, portfolio manager at Blackrock, which invests in offshore RMB for its regional products and plans to launch a dedicated RMB fund. “We’re quite comfortable with the supply pipeline in this market. The expectation is for RMB30-40 billion in the last quarter of the year: there are lots of Chinese banks, Chinese quasi-sovereigns and multinationals planning to issue.” Others think the figure could be higher.

But the third, and perhaps the most important, is that investor attitudes towards offshore RMB have changed. Where once investors appeared to be prepared to buy anything regardless of cost, quality or investor protection, times have changed, and clearly for the better.

“Initially the market was characterized by some poor quality issuance, given the excess of demand over supply,” says Lunt. “I don’t necessarily mean that the companies were bad, just that the covenants on the bonds were not tight and the yields were far too low, with disclosure below what you would hope for in developed markets.”

Investor patterns have been of particular interest to BlackRock as they prepare their fund. “Most participants looked to the market just for FX appreciation until recently,” says Tan. “There was not a lot of differentiation on the credit quality of companies in the market. But with volatility investors have started to realise that one credit is not necessarily the same as another, and have tried to work out what is the correct premium for that level of risk. That is a very healthy development.”

Changed expectations about currency appreciation are one reason for this shift, but there’s also perhaps a realisation among issuers that they need to pay more for their money in a difficult global environment. “Fund managers like ourselves are more cautious, worrying that if investors get jittery about this market they might pull funds out,” says Yeo at Fullerton. “We are adopting a wait and see attitude. But things have settled down: it’s a matter of issuers coming to terms with having to offer a higher yield to the market.” When Khazanah priced a RMB500 million deal in October, for example, it initially sought to pay a 2% coupon on its three-year deal, but accepted it would have to pay closer to 3% in the end. “When the market started, ICBC was issuing a two year bond at 1.1% and the market was lapping it up,” he says. “That will no longer be the case. Otherwise investors like ourselves are prepared to look away, buy in the Asian dollar space, and switch it back to RMB.”

Fund managers have taken a number of different approaches to the RMB market. Many of the earliest players were local, and these have tended to be more comfortable with credit. Haitong International Asset Management, for example, launched the first RMB fixed income mutual fund in Hong Kong in August 2010, following it with a private placement fund and has announced a dedicated high yield bond fund, with classes in RMB for Hong Kong investors and dollars for overseas, targeting a yearly return of 7-8%. (Haitong did not respond to requests for an update on the fund’s progress before Asiamoney’s deadline.)  Citic Securities International launched a hedge fund structure in this area, the CSI RMB Fund, which takes on multiple strategies including foreign exchange, interest rate and fixed income securities in RMB.  Earlier this year it was talking about 15-20% annual returns, including the currency appreciation; however Citic told Asiamoney it was no longer allowed to talk about the fund for regulatory reasons.

Some internationals have opted to go to the other end of the spectrum and stick with high grade. Barclays is an example: its UCITS-compliant fund will always be investment grade, on average. “There were a lot of funds launched between November 2010 and March of this year, many of them out of Hong Kong from onshore Chinese managers with a presence offshore,” says Faddy. “A lot of them are credit funds, looking to pick the eyes of the high yield market. There was a time when a lot of companies who were finding it difficult to source funding onshore could do so offshore – you could get almost anything you wanted away at a price – and several funds were set up around what was happening in the market at that time. We took a different route.” In his view, the opportunity is among deposit holders who want to get a bit extra without risking the lot. “We are really looking to provide depositors with an alternative,” he says. “Depositors have been attracted to the letters RMB, but the bank deposits carry low rates; the next iteration for those depositors in their investment life cycle will be looking for yield. A high quality portfolio of the bonds is the best alternative for depositors.”

Still others will venture into high yield, but with strict criteria around what they buy. “We would consider any bond that comes on to the market,” says Lunt at HSBC. “There are very good high yield issues available in CNH.”  But “We are absolutely determined not to invest in anything we don’t fully understand. Unrated issuance isn’t necessarily of a lower quality, but it’s very important in this market to have a very strong credit analysis platform and process.”

That will also be the attitude of the BlackRock fund when its new fund arrives. “It’s less that we feel that every high yield issuer is going to face problems; it’s more that there are some names that offer good value, and others that are less compelling,” says Neil Weller, portfolio manager.

Some internationals have taken the approach of mixing RMB bond exposure with other opportunities. In this respect, the UBS RMB Fixed Income Fund is interesting. The fund can only invest in investment grade bonds, and must maintain an average duration below three years. “Based on these two investment restrictions, we can cut down the credit and interest rate risk in the portfolio,” says Ben Yuen, head of fixed income for pan-Asia, at UBS. But against these restrictions, it can put up to 20% of its assets into US dollar Asian investment grade credit, and hedge it back to RMB. “Why? Because the market is quite green, and the universe is small for the offshore RMB bond market.” At the time of writing 18% of the fund’s NAV was used in this way.

Another distinguishing factor is that the fund can invest in RMB deposits, allowing it to invest in futures when they provide a better potential return for the portfolio. This is useful because of the way the market has been behaving: the spread between a five-year government bond in CNH and CNY is about 1.8%, but as recently as July stood at 3.4%. That sort of movement creates opportunities in futures markets.

This approach is helpful when there is high demand for primary securities. “We are not going to force ourselves to invest all our assets in bonds,” says Yuen. “We are holding short term paper to allow us to pick up higher CNH interest rate opportunities in futures. Our short-duration strategy seems quite effective in this market environment.”

Not everyone is sure these arbitrage gyrations are the right place for fund managers to be. “It’s something you’ve got to be very careful with,” says Weller at BlackRock. “The positioning is prone to get very stretched, and at times of illiquidity we’re all aware of what can happen when everyone is positioned the same way around.”

UBS’s approach of allowing some investment in Asian dollar paper is also used at Fullerton. About 25% of the fund is invested in this way. “It gives us a bit of enhanced liquidity, as I the dollar market is more developed,” Yue says. Unlike the UBS product, though, Fullerton can and does invest in high yield, and even unrated bonds; like HSBC, Fullerton assigns a credit rating to any security, and will do so through internal credit work if external ratings are not in place.

The market continues to face teething problems; one widespread complaint is that there is no investable benchmark available. But as the market develops, issues like this will be ironed out. The next characteristic is likely to be a growth in UCITS structures, reflecting increasing demand for these assets progressively further afield from Hong Kong. RMB is, increasingly, a global story.

BOX: RMB and gold

As the offshore RMB bond market has developed, more and more investment classes have grown around it. In October another was added: gold.

The Chinese Gold & Silver Exchange in Hong Kong launched the world’s first offshore RMB-denominated spot gold contract in order to attract some of the RMB circulating outside mainland China. “This product will help with that circulation, rather than the money having to stay in deposits,” says Haywood Cheung, president. Trading has to go through an exchange member – of the 171 members of the exchange, 27 had registered to trade this new contract as of late October – suggesting that initially much of the interest may be from people who physically need the gold, such as goldsmiths and jewelers. That said, there is an electronic platform for trading too, with leverage available of up to 20 times – and the ability to leverage RMB may prove the most attractive element to mainstream investors.

Part of the appeal is that both gold and RMB are perceived as safe investments. “Investors recognize gold as a safe haven, and if the gold is denominated in RMB they are double safe-guarded, because the RMB at this moment is a stable currency,” Cheung says. “It’s a win-win case.”