Vision to reality
What doesn’t kill you makes you stronger
By Brian McLeod
Traditionally, Asian fixed-income managers have had a heavy ceiling imposed on their ambitions, according to Emil Nguy, founding partner and CIO of Hong Kong-based Income Partners. Unlike the norms prevailing in the developed economies, whether that be the US, Europe or Japan, where debt markets are always bigger than their corresponding equity markets, in Asia it is the reverse.
“Here, investors, whether from the outside coming into the region, or domestic, only know one thing: stocks,” he tells Asia Asset Management. “That’s why promoting the Asian bond market has always been a challenge.”
Making things even tougher, this investor disinterest in the regional bond market has been matched by a paucity of investment opportunities therein.
Partly, the problem is structural. To illustrate this point, Mr. Nguy cites the giant US market: “It’s basically the definition of a near-ideal bond environment,” he explains. “It’s the biggest treasury market in the world, investment grade all the way through to non-investment grade. And most importantly, one single currency with reserve currency status plus one single unified regulatory regime, a huge and readily available domestic investor pool such as pension, insurance and mutual funds that are natural buyers of debt. It is thus easier for market players to grow, simply because of the market’s size and critical mass of natural buyers.”
Asia, on the other hand, is the complete opposite, he says. Ten different economies and countries, with ten different currencies, foreign exchange controls and differing regulatory regimes, triple-A to single-B as well as small and fragmented natural buyers of debt when compared against the developed countries. But back in 1993, when Mr. Nguy and his partner, CEO Francis Tjia, founded Income Partners, they didn’t see this daunting status quo as a real barrier; rather they had a mutual vision of an epic opportunity hidden within.
They reckoned that some day in the future, Asian debt markets would surpass the equity markets in terms of size, with huge potential to grow. They also noted that most of the asset managers in the region at that time and to a certain extent, currently, were run by major institutions, banks, etc. Income Partners was launched with the vision to be an independent asset manager to look after clients’ assets without any conflict of interests. Finally, after 20 years, Mr. Nguy believes that they are now at an inflection point both domestically and internationally where investors are embracing Asian bond as a core asset class in their portfolio. This coincides with the continued development of the Asian bond markets and he expects to see rapid growth of these markets in the coming years. He notes the firm had about US$200 million in AUM from 1993-1995; but by 1997 this had expanded to $600-700 million: today’s figure is $1.4 billion as of June 30, 2013.
Survival of the fittest
Over the last 20 years, Income Partners has weathered many crises ranging from the Mexican currency crisis 1994/95, Asian financial crisis 1997/98, technology bubble 2001/02, global financial crisis in 2008, and European sovereign crisis 2010/11 amongst others. Each and every crisis honed their investment acumen and served as a learning experience by the adage ‘what doesn’t kill you makes you stronger’. Income Partners has demonstrated a keen ability to evolve and innovate in the Asian bond markets. Their many milestones include launching the first Asian dedicated fixed income fund in 1993, the first Asian CBO managers 1996-99, the first Asian dedicated credit hedge fund in 2002, the first offshore investment grade and high yield RMB bond funds in 2010 and just this year in 2013, the first non-bank asset manager to receive an RQFII quota.
As Mr. Nguy sees it, the 2008 global financial crisis (GFC) has changed the world in many ways, and very pointedly for fixed income. “There’s a global rebalancing going on, especially pertaining to sovereign ratings. There is downgrading underway in the US, UK and France (to name a few) but on the flip side, upgrading in the emerging markets. This is going to be a multi-year trend because when you get downgraded, it’s not just for one quarter but rather it is a trend and development over many years: Japan, for example, was triple-A in the 1990s; now it’s double-A minus, and continuing to slide. Italy was triple-A; now triple-B,” he says.
The end result of this is a capital reallocation from credit-deteriorating countries to credit-improving countries – and we are only at the beginning of this long-term reallocation process. Also, after 20 years, the Asian fixed-income asset class itself is becoming much more definable. Income Partners defines Asian debt into three categories: First, the US dollar bond market (in essence, the Eurobond market of Asian issuers) has grown significantly compared to 1993 and is over US$1 trillion. Asia is a dollar-based economy hence; naturally, this is an asset class that will only continue to grow. Mr. Nguy continues: “Another asset class in the region are the local-rates and currency markets, which range from Korea to Indonesia, China to India and so forth – this is really the local government bond market. These markets have grown substantially since the Asian financial crisis but have different liquidity and different foreign exchange restrictions.”
The third and by far the most important one is the RMB bond market. This is the new elephant in the room and the RMB bond market has all the characteristic analogues to the US bond market. Mr. Nguy says. “This is what we have been waiting for and the emergent of the RMB bond market will change the global reallocation of capital in the coming years.” The RMB bond market is already the third largest in the world at approximately US$ 4.7 trillion in size, and according to Mr. Nguy, will eventually overtake the US as the largest bond market in the world.
In his view, we are now moving from a single reserve currency regime (US dollar) into a three reserve currency world namely, US dollar, euro and RMB. He adds: “Of course, this will take time, and it is very clear that after the GFC, the world is moving towards three major trading zones consisting of the US, Europe and China.” China is actively extending its influence to resource rich emerging market countries and the obvious neighbouring Asian trading counterparts. This will form the China lead trading zone and hence the RMB currency trading block. “Over the last 30 years, China has gone from a virtual non participant on the global stage to the world’s second largest economy from a GDP perspective. What’s more unusual, given their size, is that they have – at least up until 2010 – settled their trade primarily in US dollar. They know that this is a problem and their end game is to be a reserve currency. They have since made Hong Kong their offshore RMB centre, as an intermediate step to internationalise their currency through trade settlement. And from 2010 until now, they’ve gone from 0 to 15% of their trade now being settled in RMB.”
“This is a very fast uptick,” notes Mr. Nguy. “If you fast forward three-to-five years, and if more than 50% of their trade is being settled in RMB, then it becomes much easier for China to open up their capital account.”
Mr. Nguy’s main contention is that one of the most important precedents to being a reserve currency is to have a liquid and vibrant domestic bond market similar to the US government bond market. “China is the only country that has the potential, and most importantly, the goal, to be there,” he says. That is why he thinks that after 20 years, we are finally at the dawn of the Asian bond markets. “Of course,” he adds, “there are still many steps needing to be taken and many hiccups are expected along the way.” The main point remains that so much has happened in a surprisingly short period of time. The result? Income Partners’ optimism re: an original vision becoming reality at last.
Mr. Nguy says the vision for Income Partners is quite straightforward: “We have come a long way from 20 years ago, but now, there’s so much more to offer global investors within the Asian bond universe. Our vision for the next three-to-five years is to focus on expansion and to leverage for our clients’ benefit our deep knowledge and experience of the Asian bond markets, which we believe is second to none. We have best of breed systems and some of the best portfolio managers in the business and are the “David amongst Goliaths”. Further, with some exciting new products in the pipeline, and with the recently accorded RQFII quota, there are interesting investment opportunities available to our clients. With the right market conditions and a fast growing Asian bond market ripe with potential, the momentum has only just begun.”
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