FIXED INCOME PANEL: Betting on bonds

IndonesiaIndonesian sovereign bonds, a perpetual sukuk from GEMS Education and select high-yield issues were among the best performing assets in 2014, say the bond managers in our panel. Looking ahead, the low oil price and liquidity are the biggest challenges.

Fixed-income investors faced a variety of challenges last year. There was the ongoing guessing game about when the US Federal Reserve would increase interest rates, uncertainty over liquidity in the market, especially among sukuk, and, at the end of the year, a dramatic fall in the oil price, leading to losses on energy-related investments.

Navigating through this environment was not easy, and several of the respondents in our panel were honest about where they made losses last year. Robert Hahm of Mashreq Asset Management found that small high-yield bonds became illiquid in 2014. Because of a lack of sponsorship by the syndicates, this led to continuously falling prices. “The consequence is that we will avoid any such issues,” he says. 

In contrast, Hahm’s fund made money on its holdings of investment-grade bonds, thanks to a rally in US treasuries. Bonds from Saudi Electric, Ooredoo, DP World or OCP performed well, he says. 

Elsewhere, Jason Kabel of the Bank of London and the Middle East (BLME) found that his fund’s investment in a bond from Istanbul-based Bank Asya did not perform as well as he had hoped. He was, however, pleased with the returns on a range of sovereign sukuk from Indonesia, which is rapidly carving out a niche for itself as an Asian issuer of Islamic bonds, challenging the more established Malaysia.

Jesse Liew of BNP Paribas Investment Partners also did well by investing in Indonesian bonds, and attributed the strong performance of this segment to the victory of Joko Widodo in the presidential election race. 

Two respondents mentioned a specific issuer: the “small but widely discussed” perpetual sukuk from GEMS Education. Although Doug Bitcon of Rasmala recalls initial reservations based on the bond’s structure and use of proceeds, he felt the issuer’s good track record in the education sector and its good finances boded well for the bond. He was right  – the GEMS Education sukuk was Bitcon’s best performing investment of 2014. 

Meanwhile, Ali Soner Guney of National Bank of Abu Dhabi (NBAD) says one of his best calls was a defensive move following the fall in the oil price. He chose to invest in corporate bonds from the likes of HSBC, the bank, and from airlines, such as Emirates and Flydubai, which would benefit from lower fuel costs.

Looking ahead to the rest of this year, one interesting consequence of the low oil price could be an expansion of the MENA region’s bond markets. Fund managers are waiting to see if some of the less wealthy Gulf states decide to issue conventional or Islamic bonds to help balance their budgets this year and next.


What were your most successful bond investments in 2014?
Given the possibility of higher rates in 2014, we believed that corporate hybrids (subordinated perpetual securities) offered the combination of the best duration buffer together with the greatest carry. The equity-like bonds were the best performers in our portfolio. 

And which bond investments did not perform as well as you hoped?
Oil- and gas-related securities were the worst performers due to the precipitous drop in oil prices in the final quarter of 2014. 

In terms of government bonds, which issuers in  the MENA region  are most attractive in the coming months?
Dubai remains the most attractive issuer of government bonds in the MENA region. 


What were your most successful bond investments in 2014?
Returns were driven by both high-yield and investment-grade bonds. High-yield companies such as Topaz Marine or Dar Al-Arkan drove returns during the first half of the year on the back of a continued hunt for yield. Investment-grade bonds performed well due to the tremendous rally in the US treasury market throughout the year – for example, Saudi Electric, Ooredoo, DP World or the first-time issuer OCP, with maturities of ten to 30 years.

And which bond investments did not perform as well as you hoped?
Some issues in the high-yield sector, which were small in size, became more illiquid than we would normally expect. Investors started shunning those and lack of sponsorship by the syndicates resulted in continuously dropping prices.

Will the low oil price affect sukuk yields in the months ahead?
Oil prices will continue to affect sukuk yields. This is not specific to sukuk but affects pricing in the market in general. Some of it is driven by sentiment but predominantly it reflects the economic shift for all who produce and consume oil or oil-related products – be it directly or indirectly.

Economies that have little diversification, where fiscal spending relies heavily on oil revenues, and that don’t have an alternative access to funds – either from savings or other funding channels – will have to cut back, which will dampen their economy. On the sunny side, oil-importing countries will find their current accounts improve and the reduced energy cost serves as a stimulus. The same effects will also be observable on company levels. The sukuk market is diverse enough that as a portfolio manager you have plenty of options to rebalance your portfolio towards countries, sectors and companies that will either benefit from a lower oil price or can mitigate the effects.


What were your most successful bond investments in 2014?
The fund managers had some flexibility to reduce regional exposure in the portfolios which, at times in 2014, looked expensive relative to similar risk in markets such as Turkey, India and Indonesia. Our most successful investment was the perpetual sukuk issue out of the education sector [by GEMS Education]. We initially had reservations regarding certain aspects of the sukuk structure and the rather opaque use of proceeds. However, these were balanced by the issuer’s enviable track record in the education sector, strong brand, robust financial performance and ultimately yield on offer. 

And which bond investments did not perform as well as you hoped?
We made a conscious decision to selectively migrate down the credit curve with the view that sub-investment-grade securities would outperform high-grade securities in a low-default but rising interest rate environment. The performance of this strategy has produced somewhat mixed results as the primary buyers of fixed income assets in the GCC are the local banks which typically focus on investment-grade issuers, particularly when the market is under pressure. In 2014, regional high-yield assets generally struggled during periods of market weakness and this introduced additional volatility at times. 

In the year ahead, will falling oil prices damage returns for bond investors?
It is way too early to project the economic impact of the decline in oil prices. We are taking a protective view with respect to its economic implications and impact on investment opportunities and portfolio risk. 


What were your most successful bond investments in 2014?
Our most successful sukuk investments included Indonesian sovereign issues of different maturities and the GEMS Education Sukuk (perpetual).

And which bond investments did not perform as well as you hoped?
Our investment in Bank Asya did not perform to the extent we had hoped. 

Do you expect to see a rise in sukuk issuance compared with last year? Where will this issuance come from?
Last year’s issuance from a number of debut sovereigns paves the way for the respective corporates from those nations to issue in the sukuk market as they look to diversify their funding sources. However, we may see headwinds to that thesis as a stronger US dollar deters certain issuers from coming to market. 

From a rates perspective, we should continue to see bull flattening as the front end of the US treasury yield curve rises on the back of an eventual increase in benchmark rates, while the long end of the curve remains anchored as rates are not expected to rise substantially in the medium term. 

To that end, new issuance is likely to be concentrated in the middle to long end of the curve. This is beneficial for issuers – as they lock in funding for a longer maturity – and for investors that see more value in longer-duration sukuk. This differs from historical investor appetite, which was generally for short-dated sukuk, typically with a duration in the range of three to five years. 

With the fall in the price of oil, certain oil exporters may need to borrow in the capital markets if the price remains depressed for a sustained period.


What were your most successful bond investments in 2014?
One of the markets experiencing interesting spread changes was Indonesia, which benefited from the election results and recovery in risk aversion after the 2013 tapering announcement caused volatility. Indonesian government bonds were attractive, as yields were similar to longer-duration bonds with a similar risk profile (such as from Saudi Electricity) but with shorter maturities. The outperformance of this segment is attributed to resurgence in demand for Indonesia.

And which bond investments did not perform as well as you hoped?
Returns were in line with expectations. The relative differences in portfolio performance were driven by differences in duration strategy rather than bond selection. Our sukuk duration strategy was mostly neutral due to uncertainties surrounding the impact of the US Federal Reserve ending its quantitative easing programme. This strategy limited outperformance against most sukuk benchmarks. 

Which are the most promising sukuk issuers in 2015 in terms of country or sector?
It was promising to see several countries outside of Asia and the GCC, such as Hong Kong, the UK and South Africa, issue sukuk in 2014, a trend we expect to continue in 2015. 

The country we believe the most promising for sukuk issuance in 2015 is Indonesia. A new leadership in Indonesia’s political arena has provided hope for reform, which has already started, as can be seen by the changes made in fuel subsidies, which should help to improve the current account balance further. We believe these changes are crucial to credit rating developments and could provide greater price appreciation.


What were your most successful bond investments in 2014?
Following the correction in June 2014, we increased higher beta positions including perpetuity bonds, which yielded favourable results. Going into the final quarter, we put more emphasis on defensive names such as HSBC and Flydubai and Emirates airlines issues. These contributed well with their defensive nature during the decline in oil prices.

What effect will the low oil price have on sovereign bond yields in the Gulf this year?
Continued decline in oil prices has decreased risk appetite and diminished the size of new offerings so far. As of early December 2014, we were expecting to see a good number of new issues to come to the market. So far in 2015, we have only seen Dubai Islamic Bank coming up with a perpetuity bond. Should oil prices remain low, we could see a slower period followed by increased activity by sovereign or GRE [government-related entity] issuers.

Given the size of strategic infrastructure investments that need to be continued, sovereigns may tap bond markets in the absence of surplus profits from the oil sector. This could increase the issue size, albeit at a higher cost. Should we see a quicker recovery in oil prices, this could increase offering activity, due to an improvement in market sentiment. However, volatile market conditions could stall or slow down the issuance of new bonds.

©2015 funds global mena

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