A pivotal year for dim sum funds

Cerulli Associates: Asia Monthly Product Trends, March 2012

2011 was a pivotal year for the evolution of the dim sum bond market. Its scale grew dramatically, its range of issuers and tenors was transformed, but perhaps more importantly its whole nature changed from a frontier-spirited market in which any deal could be launched regardless of rating, to one with a more healthy balance between issuer needs and investor demands.

A large part of this evolution came from the fact that a mutual fund industry has begun to gather pace alongside the bond market itself. In December 2010, there were just six offshore RMB funds, with less than RMB800 million under management between them; one year later there were 34 funds with more than RMB4 billion under management. It is the sort of increase that almost makes percentages meaningless (467% in number of funds, 407% in assets), and reflects a market moving from infancy to a form of maturity.

Another sign of growing maturity in the industry is the fact that some diversity is already developing in fund type. There are more funds outside Asia than inside (18 to 16), although mainly this is partly just a function of domicile; HSBC’s RMB Bond Fund, for example, with around US$500 million under management, is domiciled in the Cayman Islands, but so far is chiefly populated by investors in Asia (though its new Luxembourg-domiciled UCITS-compliant fund will reach to a broader audience, particularly in Europe). 10 of those 18 are in the Caymans, seven in Luxembourg and one in Ireland; all portfolio management is done in Asia.

But it is true to say that the mandate of the funds varies.  Some of the funds, particularly those from subsidiaries of Chinese institutions, have tended to focus at the more high yield credit end of the spectrum, playing in the high-return securities that characterised the birth of the market, when names whose credit rating would probably be BB or lower if they had a rating at all were able to raise funds in reasonable size. Others, particularly those launched out of Singapore, have a mandate that allows them to look at low rated funds but in practice typically don’t; Barclays, for example, which launched a UCITS-compliant fund in Singapore in April 2011, requires that the fund’s holdings will always be investment grade, on average. That fund’s approach is to give RMB depositors a bit extra without risking the whole lot. HSBC and Fullerton can venture into high yield under strict criteria, vetted through a credit analysis platform.

One interesting approach in new funds has been to mix RMB bond exposure with other asset classes. The UBS RMB Fixed Income Fund, for example, can only investment in investment grade bonds, and must maintain an average duration below three years, but can put up to 20% of its assets into US dollar Asian investment grade credit and hedge it back to RMB. That is intended to get around the fact that the universe in the RMB offshore bond market is still relatively small. It can also invest in RMB deposits, so that it can invest in futures where the portfolio managers believe they represent a better potential return for the portfolio.

Fullerton Asset Management in Singapore also has an RMB fund which can invest up to 25% in Asian dollar paper, giving more liquidity and greater investor choice. It is likely that this model will fade once there are sufficient securities in RMB to make proper diversification possible.

Flows into new products have, unsurprisingly, been very strong in a new market, but not exclusively so. As figure 2 shows, some locally domiciled funds, from United and Manulife, experienced negative net new flows in 2011, though they were unusual; Ping An’s fund represents the reverse experience with US$224.5 million of NNF between late April and November and just one single day of net redemptions along the way. A look at that chart also shows that funds have had mixed success in building critical mass, with Haitong (the first mover) and Ping An way ahead of some established names one would have expected to do better, such as ICBC and CCB.

One reason that some funds have suffered outflows is because of a major change in the view of the currency itself in the latter part of 2011. Originally, many investors bought into RMB bonds somewhat indiscriminately because of a belief that the currency would appreciate against the dollar (and therefore the Hong Kong dollar too, since the two are pegged) by about 5% per year, come what may. Following global volatility in September, that view started to change; most analysts today predict 3 to 4% growth with a lot more volatility. That has started to change the view on the bond market from a pure currency play to one in which careful analysis is necessary, and seeing that, some investors have opted to do other things with their money. On top of that, the widening of credit spreads on many bonds during that period reduced performance and caused some investors to pull out, though equally this could be said about more or less any fixed income market.

Another sign of growing maturity is the quality of the names involved. Alongside the biggest names in Hong Kong and China – names like Haitong, Hang Seng, Citic, Ping An and of course HSBC, most of them early movers – have come some of the biggest names one has come to expect in any important debt market: Schroders, UBS, Barclays, BlackRock. Their presence, and the buyer base they represent – broader than just Greater China and Singapore, and going beyond retail to institutional and high net worth – is a further illustration that the market is finding its feet and becoming credible.

All mutual funds in this area face challenges. There still aren’t really enough issues. Getting allocation into the right issues is a problem. The secondary market is illiquid. The curve is improving – a recent China Development Bank issue went to 15 years – but largely concentrated in the short end. The swap market, though also improving, remains weak, which impedes issues from foreign issuers who don’t need the RMB for local purposes but hope to swap it out. There are still too many issuers without the covenants they would expect to need in dollar issues. And there’s not really a suitable benchmark. But it’s likely that a year from now, all of these things will look better, and that the existing funds will have been joined by many others.

MANULIFE AM

• The Manulife China Dum Sum US$ High Yield Bond Fund launched in July. It was notable for being the first dim sum fund to be launched in Taiwan, playing on the thawing of relations between Taiwan and mainland China which allows Taiwanese investors (and institutions) to put money into Chinese securities.
• It started well, hitting US$137 million in assets under management in its month of launch. Unfortunately, that proved to be bad timing; after modest increases through September, the world entered a period of enormous volatility that hit bond funds worldwide. Between September and October the fund suffered $18.7 million outflows, followed up with $8.2 million in November and $10.7 million in December. By the end of the year it had US$113.1 million under management, considerably less than in its month of launch.
• September and October were a period of poor performance in all bond markets – pretty much all asset classes, in fact – but declines do appear to have stabilised in the last three months, despite the fact that performance has lagged dim sum ETFs in that time.
• The fund is touted as offering exposure to high yield bonds, but it is illuminating to note that its top holdings, when last disclosed, were often not high yield. The largest holding when last disclosed was Chinese government bonds, followed by Export-Import Bank of China, then GLP (a real estate group part owned by Singapore’s GIC sovereign fund), Cofco and Sinotruk. Only the last two, and arguably the last one, really fit the bill.
• Manulife offers two funds in Taiwan, with a second one – Manulife China Offshore Bond A – launched in November, and attracting AUM of $93.1 million by the end of the year. This appears to be aiming at a more investment grade approach.