* Risk appetite rebounds in Asian debt markets
* Money still flowing into emerging market funds
* Bankers predict tighter pricing and more deals
By Christopher Langner and Neha D'Silva
Oct 5 (Reuters) - A sudden rebound in risk appetite caught Asia's debt capital markets bankers by surprise last week, but the renewed confidence quickly triggered predictions of tighter pricing and heavy dealflow.
"With flows into emerging-market bond funds and a healthy redemption calendar in October, there still is plenty of money on the table," said a senior DCM banker in Hong Kong. "We are going for negative new issue premiums."
While the previous week had been all about profit-taking, investors now seem willing to jeopardise solid gains from the first three quarters of the year for the prospects of even greater gains. That dynamic caught syndicate bankers by surprise, and made them misjudge investor interest in new issues.
After seeing three high-yield deals flop and new issue premiums on investment-grade bonds inch up in the last week of September, bankers figured the US$105bn-plus in international bonds printed this year from Asia had left investors with some indigestion. Investors were talking about defensive strategies, worried about securing the double-digit returns they have logged in so far this year.
However, the new five-year Reg S-only US$300m bond from Indian Railway Finance Corp last Wednesday was a clear example of how quickly the mood has changed. "I had thought we'd hit a wobble but this week has been absolutely incredible," said a DCM banker not involved in the deal.
Fuelled by US$3.6bn in demand, the quasi-sovereign tightened guidance 30bp from initial price talk - the biggest review from an Indian issuer in the dollar market this year. Yet, the bonds still tightened another 12bp on the break.
The clear mispricing gave critics reason to point fingers at leads Bank of America Merrill Lynch, Barclays, Citigroup, Deutsche Bank and JP Morgan. But they can hardly be blamed. Had they done the deal a week before, when investors were focused on securing their gains, that large new issue premium would have been needed.
One piece of behavioural psychology may offer an explanation.
In 2002, Daniel Kahneman won a Nobel Prize in economics for his study with Amos Tversky on the psychological drivers behind economic risk-taking or aversion - something the two scientists called prospect theory. There have been numerous follow-ups to the groundbreaking findings, including a much-discussed paper by Vanguard strategist Stephen R. Utkus last year entitled "Market bubbles and investor psychology".
In it, the strategist stated that in the creation of a bubble, there is a "tendency for forecasts of the future to lead to overconfidence and, in particular, for market participants to extrapolate recent positive news into the future." Peer pressure, or "group transmission", and recent memories of gains amplify that effect, according to Vanguard.
In this case, it took only a handful of positive headlines from the United States to remind investors of their recent gains and tempt them back into the market. If IRFC were not proof enough of that, brokers were reporting a flurry of one-way buying last Wednesday and Thursday. "My traders were having a hard time finding sellers for the bonds being bought," confided a banker in Hong Kong.
Rumours that one large Western fund had reallocated US$450m into EM high-yield also had traders chasing any lower-rated bonds available in Asia, buoying that asset class as well. In spite of the bullish drive, though, the market is getting trickier and some of the recent rally looks more related to "group transmission" than fundamentals.
Morgan Stanley noted that in a report on Thursday: "The case for further upside in EM remains underpinned by durable inflows (and a robust new mandate pipeline) and the after-effects of the recent bout of developed markets policy action." However, the report went on: "Valuations are now less likely to be a key driver, given the rally in recent months. In addition, event risks may increase volatility in the weeks ahead, challenging investors' resolve into year-end."
In short, any unexpected events that turn the sentiment negative as fast as it turned positive could unleash the last stage of the cycle described by Utkus: "Recalibration of expectations with reality." Until then, it is risk-on.
(Reporting By Christopher Langner and Neha D'Silva; Editing by Steve Garton)
Keywords: BONDS/RISK AVERSION