Asian Sovereign Credits: Investors’ Perspectives

Asian Regional Public Debt Management Forum,

3-5 November, Malaysia

Hon Cheung

November 2009
Overview of Presentation
Increasing the appetite for Asian government bonds

Asian local currency bonds – the end-investors’ perspective:

The strategic case for Asian local currency bonds
The role of indices
What are the challenges for fund managers?
Trading and operational issues
Regulatory
Improving access
Bond funds
ETFs

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End-Investors: the Relevance of Asian Local Currency Bonds

The strategic case for Asian local currency bonds:

1) Core asset class
2) Diversification benefits
3) Attractive currency markets
4) Attractive returns with moderate volatility

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 1) A Core Asset Class

More than doubled in size to US$4.3 trillion since 1997*

10 times greater than G3 denominated Asian bonds
Now commanding 5% of the world’s bond markets
Most markets now offer liquid yield curves of over 10 yrs
Infrastructure greatly improved
Introduction of efficient settlement and clearing systems
Rapidly developing derivative markets
Liberalization of interest rates
Increase in institutional products on offer

Source: * HSBC Research, ADB (as of December 2008)

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2) Diversification Benefits for International Investors

Trend: Rising correlations Asian Bonds: Diverse range of currencies

between major markets vs. US
Established markets
Core markets
1996- 2001- High yielding markets
2000 2009*
Asian Bonds: Low correlations with
Germany 0.63 0.81
developed markets
UK 0.60 0.78

Japan 0.20 0.37 US Pan Asia

US 1.00 0.36
Australia 0.61 0.71
Germany 0.81 0.26
UK 0.78 0.39
Source: SSgA, based on monthly returns of Citigroup Japan 0.37 0.19
Government Bond Indices from January 1996 to
September 2009. Australia 0.71 0.26

Source: SSgA, based on monthly returns of iBoxx Pan-Asia Index &

Citigroup Government Bond Indices from January 2001 to September 2009.

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 3) Exposure to Attractive Currency Markets

Historically, currencies have been a significant contributor to Asian local

currency bond returns:
Annualized contribution from currency returns = +2.3%
Annualized contribution from market returns = +5.7%
Annualized total return on Asian bonds = +8.0%
Rolling 1-Year Returns on Asian Local Currency Bonds (Unhedged)
20%

15%

10%

5%

0%

-5%

-10%

-15%
2002 2003 2004 2005 2006 2007 2008 2009
Currency Market Market + Currency
Source: Markit, iBoxx ABF Pan-Asia Index as of 30 September 2009

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 4) Attractive Overall Returns with Moderate Volatility
For the past years, Asian bonds have delivered good returns with low
volatility
Annualized return: Asian bonds = 8.0% US bonds = 5.4%
Volatility: Asian bonds = 6.0% US bonds = 4.2%
Rolling 1-Year Returns on Asian Bonds and Comparable US Duration Adjusted Bonds
20%

15%

10%

5%

0%

-5%

-10%

-15%
2002 2003 2004 2005 2006 2007 2008 2009
iBoxx ABF Pan-Asia Index US Duration Adjusted Bonds

Source: Citigroup Government Bond Indices, Markit and SSGA

(as of 30 September 2009)

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 The Role of Indices

Inclusion in an index can help promote the visibility of the market

Large index weights can create flows from active and passive managers
Examples of recent changes to the Citigroup World Government Bond
Index:
Inclusion Sept 09
date weight

Singapore Jan-2005 0.26%

Malaysia Jul-2007 0.37%

Korea soon est. 1.4%

Source: Citigroup World Government Bond Index

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 Index Providers Approach to Inclusion: Example for Korea

The process of considering inclusion of Korea into the Citigroup World

Government Bond Index is instructive*:
“Based only on the size of the Korean market (the Citigroup Korean
Treasury Bond (KTB) Index), South Korea is large enough to be
included”
“However, there have been considerations other than size that have
consistently prompted this committee to postpone inclusion. Chief
among those considerations has been the inconsistency of withholding
tax based on the country of domicile of the bondholder”
“This year, the Korean government eliminated withholding tax for all
foreign bondholders, thus eliminating our biggest objection”
“This committee views this policy change as an important step in
improving the desirability of the South Korean market, which has
prompted us to reconsider inclusion at this time”
Source: *Citigroup World Government Bond Index, July 2009

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 Indices: Fund Manager’s Perspective

Managing against Asian bond indices can be a challenge

An index bond fund is a very severe stress test of index construction
Example: market weight changes for iBoxx index
Market Weight Jul 05 to Oct 05 to Oct 06 to Feb 07 to Nov 07 to Nov 08 to Nov 09 to
(%) Sept 05 Sept 06 Jan 07 Oct 07 Oct 08 Oct 09 Oct 10

China 11.28 11.24 12.26 12.32 14.89 17.77 20.87

Hong Kong 17.05 18.30 18.36 18.56 20.20 19.15 19.26

Indonesia 6.14 5.99 5.94 6.06 6.43 5.64 5.37

Korea 21.26 20.67 20.84 20.96 17.05 16.40 14.20

Malaysia 10.76 10.70 10.22 10.37 10.81 10.59 10.58

Philippines 5.19 4.96 5.14 5.26 4.78 5.24 5.44

Singapore 18.70 18.22 17.73 17.92 15.64 14.92 14.82

Thailand 9.62 9.92 9.52 8.56 10.21 10.31 9.46

Source: Markit, iBoxx ABF Pan-Asia indices

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 Example of Challenges: Market Weighting Methodology
The iBoxx ABF index uses a factor based approach

A factor based approach adjusts market weightings according to the

degree of impediments

Market Market
Market Size (USD bn.) Turnover ratio Credit rating
functionality weight
China 2,192 3.2 AA- 40 20.87%
Hong Kong 100 8.0 AA+ 100 19.26%
Indonesia 73 0.5 BB+ 65 5.37%
Korea 796 1.4 AA 70 14.20%
Malaysia 160 1.8 A+ 80 10.58%
Philippines 56 1.1 BB+ 60 5.44%
Singapore 120 2.4 AAA 100 14.82%
Thailand 147 3.1 A- 65 9.46%

Trading, operational and regulatory impediments score

Source: Markit, iBoxx ABF Pan-Asia indices 25 September 2009

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Fund Manager’s Impediments: Trading and Operations

Size of markets
Tightly held bonds
Liquidity
Lack of hedge instruments

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Fund Manager’s Impediments: Regulatory Issues

Restrictions on foreign exchange

Use of onshore and offshore markets
Other dealing restrictions
Extensive regulatory reporting
Withholding taxes

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Withholding Taxes: History of WHT Exemptions

Market Year Exemption

Government bond and other debt interest

Singapore 1998
income for non-residents

Government bond interest income for non-

Malaysia 2004
resident companies

Government and other bonds interest

Thailand 2004
income for bonds sold abroad

KTB interest income and capital gains are

Korea 2009
exempted for foreign investors

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Improving Access

Improving access for whom?

Institutions
Retail
Access medium
Bond funds (e.g. infrastructure)
Exchange traded funds
Exchange bond dealing initiatives

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Thank Youank You
Biography

Hon CHEUNG, hon_cheung@ssga.com

Hon is the Regional Director for the Official Institutions Group in Asia
and has responsibility for developing relationships with central banks,
sovereign wealth funds, sovereign pension funds and other
government agencies in the Asia Pacific region. Hon joined State
Street Global Advisors in 1996 and has served senior roles in the
London, Hong Kong and Singapore offices. He has worked closely
with stock exchanges, government bodies, pension funds and other
institutions in Asia to advise on investment matters; most recently, he
led the team that designed and managed the ABF Pan Asia Bond
Index Fund which was successfully launched by Asia’s leading
central banks. Hon holds a degree in Mathematics from Imperial
College London and a Diploma in Mathematical Statistics from
Cambridge University. He is also a member of the Institute of
Chartered Accountants in England and Wales and sits as a member
of the independent index committees for a number of index providers.

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Important Information

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statements are based on certain assumptions and analyses made by SSgA in light of its experience and
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