By Stephanie Jacob
Bonds are often seen as the safer, if less exciting investment option to have in one’s portfolio. Although they do not offer the same returns as the stock market, Investopedia underlines the benefit of bonds saying: “all it takes is a bear market to remind investors of the virtues of a bond’s safety and stability”.
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Although Malaysia’s stock market has been going through a lengthy bull run over the past year, there are signs that it is beginning to slow. Therefore for the investor looking for a more stable and long term investment, bonds may be a good option.
However, with inflation rates set to rise in the coming months, this may not be true for longer term investors. Interpac Securities’ Head of Research Pong Teng Siew notes that although “bond yields have been falling, they are at a level that is anchored by the possible rise in inflation.” He added that any additional subsidy rationalisation and the introduction of the goods and services tax next year will lead to a rise in inflation.
In this piece, we look at the state of the local currency bond market and analysts forecasts on the direction it is set to take in the second half of 2014.
The Malaysian bond market
Malaysia has the biggest local-currency bond market in the region, and the fourth largest in Asia. According to data compiled by Bloomberg, Malaysia sold RM117.8 billion of debt last year as companies helped finance various government initiatives.
At the end of the first half of 2014 (1H14), government bond supply issuances amounted to RM45.5 billion in Malaysian Government Securities (MGS) and Government Investment Issues (GII). There was also an additional RM6.6 billion raised from Sukuk Perumahan Kerajaan (SPK).
The indication by Bank Negara Malaysia’s Monetary Policy Committee in May that an interest rate hike was imminent led to a decline in demand for short-term bonds. Maybank Investment Bank’s (Maybank IB) Winson Phoon said: “market expectation of an imminent rate hike dampened demand for short-end bonds…as evident from the poor 3-year MGS auction.” However the bearish auction tone appeared limited to short bonds, and demand for the 20-year GII auction was healthy.
As for private debt securities or corporate bonds, primary issuance was RM40.1 billion at end June. Government guaranteed and AAA-rated papers accounted for about 55% of all issuances. In terms of sectors, infrastructure, utilities and financial issuers dominated issuing a combined 64% of all private debt securities.
Outlook for 2H14
Looking ahead to the second half of 2014 (2H14), analysts see the near-term outlook for the bond market as being positive.
In his market outlook report, Maybank IB’s Winson Phoon said that for the MGS, the near-term outlook remains good on the back of favourable supply and demand. He added however that the research house is taking a “slightly bearish long-term view on the market as pricing is getting richer.”
Maybank IB is expecting BNM to raise interest rates by another 25 basis points before the end of the year. Phoon said that current yield levels appear to have not accounted for this potential hike and that there could still be “some upside re-pricing in yield, primarily for the more interest rate sensitive front ends.”
MGS are expected to be less attractive in the latter half of 2014, said Phoon. Adding that investors should consider GII and SPK issuances which are likely to be more attractive, even though there is lower liquidity for these two options.
Nor Zahidi Alias
Malaysia Rating Corp’s (MARC) chief economist Nor Zahidi Alias concurred, saying “real interest rates turning negative has lessened the attractiveness of MGS as an inflation hedging instrument”.
In his 2H14 Bond Market Outlook report, Zahidi said “that the benchmark yields of shorter-term MGS is now lower than the inflation rate. Which may lessen MGS attractiveness when compared with major sovereign bonds and selected regional bonds”.
MARC expects there to be an upside bias in MGS yields following BNM’s interest rate hike in early July. Zahidi said “we are maintaining our forecast of an upside bias in MGS yields with a bearishly flattening yield curve”.
However, he said that the rise in the yields will not be too significant on the back of the European Central Bank’s stimulus measures which are expected to exert downward pressure on global bond yields, including in Malaysia.
Furthermore local institutional investors will also likely continue to provide critical support to the MGS market should yields rise significantly, noted MARC.
What should investors do?
Traditionally, the Malaysian bond market has been inaccessible to the average retail investor. Bonds are usually traded in the over-the-counter market, with institutional investors and high net worth individuals being the main participants. Minimum investments tend to be in the hundred thousand ringgit to several million ringgit region.
Earlier this year DanaInfra Nasional Bhd, which is tasked with raising funds for the MRT project issued the first exchange bonds to retail investors. DanaInfra issued RM300 million of government-guaranteed Islamic securities, with a minimum order value of RM1,000, in RM100 increments.
Unit trust funds remain the most popular way for retail investors to access the bond market, and many financial institutions offer a variety of products to their customers.
Most bond fund managers “will try to position for capital gains by exposure to the 10-year bonds, that will give you the best and fastest returns at the moment,” said Interpac’s Pong Teng Siew. However, he adds that longer term bonds are not that liquid and there is a limited supply of them. making them difficult to get.
An investor looking at putting money into bonds as a means of generating income, will have to contrast the current yield levels against inflation rates to evaluate if they are a worthwhile investment, said Pong. He pointed out that the current yield for 10-year bonds at 3.86, is perhaps not attractive given that the inflation rate is at around 3.4% and is expected to rise.
“In the very near term, with bond yields all coming off, it looks like a reasonably attractive proposition — especially in the long term bonds. Just for awhile, I think maybe 6 months, or maybe even less than 6 months. If you are holding it for a trading position, then these long-term bonds look quite attractive. But if you are looking to invest in it for a year or more, then I have my doubts as to whether yields are going to remain so low as inflation pressures build up.”
Maybank IB’s Winson Phoon also suggested that the current bond market was better suited for investors with short-term investment horizons, given that the near term outlook for MGS yields remains positive.
Phoon also cautioned that it is increasingly unattractive to exchange duration for yield. He said that “as the MGS curve continues to flatten, we think it has become increasingly unattractive to extend duration risk for yield.”
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