Corporate Bonds

Wealthy Asia Investors May Cool to Corporate Bonds as Deals Sour

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Asia's wealthiest investors may lose some of their appetite for corporate bonds after getting burned in recent deals, analysts and bankers say, sowing caution in a market where issuance hit a record this year and hiking funding costs for riskier borrowers.

Retail investors, lured by returns of nearly 20 percent so far this year in sub-investment grade bonds - better than Asian equities - have grabbed up a bigger share of the region's corporate bonds than ever before, analysts say.

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That spurred some companies typically shunned by the bond market to issue debt, and now some of those high-risk deals are beginning to sour, including recent issuance by commodities firm Olam International Ltd. And that is making investors wary.

"Retail investors have been jumping into any issue and always trying to search for the highest yield, not always being aware of the risk of individual bonds," said Gary Dugan, chief investment officer of Asia and Middle East at Coutts, British lender RBS's private banking arm.

"As we step into 2013, people will be more circumspect in the way they invest."

Private-wealth investors are also being lured back to the equity markets, Dugan and others note, by signs of an improving economic outlook and a pickup in company earnings, which in addition is helping to put a damper on corporate bond yields.

Their reduced presence in the bond market will be sorely felt by borrowers such as Olam, among the riskier Asian issuers with higher default risk and lower credit ratings - if they have a rating at all - but paying out among the highest coupons.

Olam Exposure

Private-banking clients, who typically have at least $200,000 to invest at a time, had come to underestimate corporate bond market risks, analysts say. In some cases this year they have bought up more than half the bonds on offer from some of Asia's riskier corporate issuers.

They were particularly exposed when Olam, which sold $500 million in five-year bonds in September, was targeted by an attack from short-seller Muddy Waters, which put the commodities firm's high debt levels under the spotlight.

Private-wealth clients bought an estimated $350 million of the Olam bonds, attracted by a 5.75 percent annual interest payment. But the dispute with the U.S. research firm, which also questioned Olam's accounting, knocked as much as 17 percent from the bond price.

Those losses could mean that Olam and similar firms will have to pay more to raise funds in the future.

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Olam's bonds due in 2020 are trading at a yield of 8.6 percent, compared with the 7.5 percent they were issued at in 2010, indicating the higher rates they would face if they returned to the market in today's environment. The 5.75 percent bonds due in 2017 are yielding 7.6 percent.

This is also, however, signalling a return to a more normally functioning market. "Caution on the part of private banking investors is not necessarily a bad thing as it means pricing discipline and that credit selection will be better," said Ronan McCullough, Morgan Stanley's Asia head of debt capital markets syndicate.

Hot demand for Asian credit helped to fuel a boom in issuance, with the hard-currency bond issuance tally - in dollars, euros and yen - at a record $133.4 billion this year, dwarfing the previous record of $84.6 billion in 2010.

Private-banking clients accounted for roughly 16 percent of corporate bond purchases in the region this year, up from 12 percent in 2011 and 6 percent in 2008, according to consultant Asia Credit Advisors.

When Hong Kong-based retailer Li & Fung sold $500 million in bonds last month, retail investors accounted for 60 percent of purchases, up sharply from just 15 percent when it sold $400 million in bonds in 2010 and a negligible portion of its $500 million deal in 2007.

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Indian Overseas Bank, which leveraged on expatriate Indians at its debt sale, boosted the portion of retail buyers to 35 percent in its August issue this year from 24 percent at its 2011 issuance. Both were for 5 1/2-year bonds.

Higher Returns

The attraction was simple: As economies cooled and central banks cut interest rates, corporate bonds offered relatively higher returns than equities when stocks looked susceptible to a weaker business climate.

Asian corporate bond markets in 2012 have generated their second-best returns ever, surpassed only in 2009, according to Morgan Stanley. The sub-investment grade bonds favoured by private wealth clients returned 19.6 percent in the first 11 months of the year, according to the J.P. Morgan Asia Credit Index, while the MSCI index of Asian stocks returned 16 percent.

For the longer term, bonds will also attract increasing investment because of demographic drivers - as Asia's societies age and grow wealthier, they will look to the bond markets as a relatively safe place to park their nest eggs for retirement.

"The private banking involvement had risen in the past five years as retail investors have become more sophisticated," said Anita Yadav, managing partner at SJ Seymour Group.

"There has also been a paradigm shift as an ageing population means more allocation to fixed income and the region getting richer means there is more absolute savings."

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The growing demand for Asian bonds had also been driving down the interest rates that companies have to pay. Longfor Properties borrowed seven-year money at 6.875 percent in October of this year, compared with the 9.5 percent it paid for just five-year funding last year in April.

This proved to be a double-edged sword, however, driving investors to ever-riskier bonds in search of high yields, and increasing the chance of Olam-style losses that would in turn leave them more wary of the market.

"The worry is that many investors keep looking for a certain level of nominal yield and you would have to take considerably more risk to get that yield instead of three or four months ago," said Coutts's Dugan, who recommended that investors become more discerning and start cutting risk.

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Olam's five-year bond was only one of several issues that have turned sour for individual investors.

Property company SOHO China 10-year bonds , nearly half of which were bought by individuals when they were sold last month, fell 7 percent within days of their sale, unable to sustain the investor enthusiasm that greeted their issuance. They continue to trade below par.

China Fishery Group sold $300 million in seven-year bonds in July this year, 13 percent going to individuals lured by its 9.75 percent interest rate. But since an enquiry by regulators cast doubt on its fishing rights in Russian waters - where it gets two-thirds of its revenue, operating profit and operating cash flow - the bonds have dropped about 25 percent, while ratings agency Standard & Poor's downgraded the bonds to B from BB-.