Brunei looks to steer economy away from the oil and gas sector
Category: Asia, China, Hong Kong, Japan, Korea, Malaysia, Philippines, Singapore, Thailand, U.S.A., Brunei
Islamic finance showing good potential
The liberalisation of the yuan is opening up a host of new opportunities in centres such as Hong Kong and Singapore; from trade finance to investments, settlement volumes in yuan are growing by the day. Brunei, too, is keen to tap into these opportunities. One example could be to issue sukuks (Islamic bonds) in Brunei denominated in yuan, says a senior Brunei official.
Speaking at Asia Asset Management’s 7th Annual Brunei Roundtable in the country’s capital last month, Dato Ali Apong, deputy minister in the prime minister’s office and chairman of the Brunei Economic Development Board, says that there are opportunities to issue yuan-denominated sukuks in the local capital market. Dato Ali says that as China develops an offshore yuan market in Hong Kong, Brunei is also keen to participate in this development given the increasing trade and investment links between both countries. To date, sukuks that have been issued in Brunei are denominated in the local currency or the US$.
“With an RMB window, that will help to greatly facilitate trade and investments between the two countries and will help to mitigate foreign currency instability for our investors,” adds Dato Ali. As in Hong Kong which is the main offshore hub for yuan trading, there could be possibilities to offer yuan denominated products.
As Brunei continues with its reform agenda, one key objective is to continue with its diversification of the economy away from the oil and gas sector; finance and financial services are one area of this focus and the reforms in place for the sector culminated with the establishment this year of a central bank, the Autoriti Monetari Brunei Darussalam (AMBD).
Brunei’s credentials as an Islamic finance centre are undeniable and for both portfolio and private equity investors, there is now a growing group of asset managers and fund managers onshore. An Islamic private equity (PE) fund to invest in the region has been established. A conventional PE firm, Aureos BICB Advisers, opened its doors two years ago and has since invested in two domestic projects; two more investments are planned this year and next. Aureos BICB Advisers was established in collaboration with the Ministry of Finance.
In broadening out its economy, the contribution from the non-oil and gas sector has increased significantly. In his key-note address, Dato Ali notes that non-oil and gas industry’s contribution to GDP has risen from 27% in the past 15 years to 40% in 2009; the contribution from the finance sector is about three per cent to GDP. “There is potential to grow this, especially in Islamic finance,” he adds. Among the possibilities for fund managers to consider could be the establishment of an Islamic index for the Greater China region, he notes. “Funds may be launched to track this index and they could be based in Brunei.”
Speaking at the same event, the deputy managing director of AMBD, Chong Fu Li, says that the newly set up central bank is keen to pursue closer ties with its regional colleagues. “As the new kid on the block, there is much to learn from other more established regimes,” he adds.
Mr. Chong says that prospects for Islamic finance are bright given the advantages that the regime offers. “The first sukuk was introduced in 2006 and since then, the market has grown significantly.” Two decades ago the first Islamic bank was launched and now assets in the system represent some 37% of the total. “Growth in the past decade has been averaging 21% a year,” he says.
In his presentation entitled “Asia: Emerging or Emerged?”, Christopher Darling, director of Asian research and a senior portfolio manager at Lloyd George Management, says the region’s rapid wealth creation in the past two decades has led to dramatic changes in investment and consumer behaviour.
Some countries have surged ahead while others have lagged; indeed, a number of countries in the region have yet to see domestic investments exceed pre-1997 levels, the year when the Asian crisis blighted the region. Countries such as Thailand, Malaysia and the Philippines have seen domestic investments tail off after the crisis and have not recovered since then.
Interestingly, if GDP per capita is used as an indicator of how Asian economies have fared in the past decade, Singapore has unquestionably performed best, surging to US$43,871, ahead of Japan’s $42,948. Singapore’s strong performance has also been aided by the recent strength of its currency; in contrast, per capita GDP for Hong Kong, is just under $32,000.
In 1984, Korea’s GDP per capita was about the same level as Malaysia’s. Now, Korea’s per capita is more than twice that of Malaysia’s ($20,770 versus $8,422). “There is a possibility that some countries in the region will remain stuck in the middle income trap as their costs rise while their competitiveness falls,” he says. “Will China fall into this category?” he asks rhetorically.
Describing the landscape for Asian high yield bonds, Philip Wickham, head of credit research, DBS Asset Management, says that activity has picked up post the 2008 crisis; new issues have largely been dominated by corporates from China and Indonesia. A sizeable number of Chinese issuers have been property companies.
In the first quarter of this year, the number of issues topped $8.8 billion, more than four times the amount raised ($2.1 billion) in the first quarter of 2010, reflecting the growing demand for this asset class from institutional investors, many of whom are from outside the region. Fund flows into emerging market bonds since January 2009 have been growing steadily. Typically, a $2.5 billion sovereign bond issue from Indonesia in April this year was well received.
To be sure, though, the Asian high yield market remains small relative to the markets in US and Europe. “Diversification within the high yield space is elusive and is largely restricted to issuers from China, Indonesia and the Philippines,” observes Mr. Wickham. The high yield market also has a higher correlation to equities than investment grade fixed income.
Because of the higher risk profile of this asset class, quite a number of pension funds and institutional investors are not able to invest in these securities for now. This may well change as the market improves in both depth and liquidity in the years ahead not to mention corporate governance standards and practices.
According to Mr. Wickham, the environment for bond holders in Asia is less friendly compared to the regimes in the US and Europe; legal protection is less well developed outside of the markets of Hong Kong, Singapore and Australia.
In terms of opportunities in the US, participants at the Brunei Roundtable also learnt about the potential in the small to mid-cap sector. John Power, senior vice president, head of US equities at Pyramis Global Advisors says that the small to mid-cap sector in the US is seeing more inflows as investors devote more of their risk budgets to less efficient parts of the market. “The less efficient the market, the higher the opportunity to generate alpha,” he notes.
He points out that small and mid-cap stocks have outperformed large cap stocks over the last five, ten and 15 years, pointing to the superior returns not only on an absolute basis but also after adjusting for risk.
While the historical returns have been impressive, going forward Mr. Power says the case for investing in the sector is buttressed by a number of factors. “We often find that these companies are innovative, more so than the large cap sector, and that they are positioned in the fast growing segments of the economy such as technology, consumer discretionary and retailing,” he explains. The earnings growth of these companies, as a result, are higher than their bigger colleagues.
And as evidence of their growth, a growing percentage of these companies are exiting the Russell 2000 index. Interestingly, too, small and mid-cap stocks have been expanding their footprint outside of the US in recent years to tap into some of the faster growing markets. Given their profile, they are also appealing targets for mergers and acquisitions, Mr. Power points out.
Meanwhile, the world of quantitative investments is moving forward following the challenging environment during the financial crisis, especially in the second half of 2008. Then, the “quants” were struggling to make sense of the investment world – along with the rest of the global investment community – which had been turned on its head as events quickly unravelled; many pension funds saw losses of 30% or more in that year.
According to Alex Neve, head of investment specialists at Dutch firm Robeco, there’s no black box as such to the firm’s investment process. “We pride ourselves on being transparent,” he says. The quantitative approach, he adds, does not work on the basis of optimising the past and putting in the factors into a model, thinking that will show the way forward.
Mr. Neve says that in adopting the balanced approach, the variables that work for developed markets also apply for emerging markets. “We think that when we capture behavioural finance, the characteristics should be common to both developed and emerging markets,” he adds. Moreover, in investing in emerging markets, he notes that using off-the-shelf optimisers that employ correlation matrixes tend to break down during market stresses. “We have developed our own proprietary models to address this,” he notes.
Recently, Robeco has embedded responsible management into its models for developed markets alongside valuation and sentiment factors and this has proved itself in enhancing the long-term risk return profile. But the lack of data in emerging markets in this area is hampering its inclusion of the factor into its model, at least for the time being.
Discuss: Brunei looks to steer economy away from the oil and gas sector