Risks behind RMB-dominated bonds

Hong Kongers have hailed the issues of Renminbi-dominated bonds although many investors may have limited knowledge about bonds. Are current RMB bond issues really worth cheering......

YT Kum, CFA 30.08.2007
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Hong Kongers have hailed the issues of Renminbi-dominated bonds although many investors may have limited knowledge about bonds. Are current RMB bond issues really worth cheering? Investors should dig deeply into the risk factors. In sum, RMB bond investors face three major kinds of risks: 1) Currency risk; 2) Liquidity risk; and 3) Interest rate risk.

Currency Risk
Taking 3 percent coupon rate together with 4 or 5 percent expected annual appreciation of RMB, the expected return of the latest RMB bond would be around 7 or 8 percent per year. It is quite enticing for general investors as it is much higher than the current saving rate and even the average three-year annualized return of Morningst

ar Asia Bond fund category.

Since a 3 percent coupon rate is not as attractive as other risk-free assets (assuming both China Development Bank and The Export-Import Bank of China, two latest RMB bond issuers, are credit risk free), the currency gain must have played a crucial part of the bonds' gravitation. Riding on the robust economic growth, RMB should be poised well for a long-term appreciation; however, the pace is uncertain, largely up to PRC government policy and international political pressures. Investors should not assume the 4 or 5 percent currency gain as “guaranteed”.

Liquidity Risk
Bond investors who do not intend to hold the bonds to maturity need to pay attention to the liquidity in the secondary bond market, as they may have to sell their holdings at deep discounts if the liquidity is low. The Asian bond market is not as liquid as big markets like the U.S. treasuries at present. Investors should not expect the illiquidity of Asian bond market, especially for RMB denominated bonds, could be improved in near term. The reasons are 1) The issue of RMB bonds is not on regular basis, unlike U.S. treasury securities; 2) Most HK investors invest in RMB bonds for saving purpose or capital preservation and they are not active in the secondary market. Indeed, as long as investors intend to hold the bonds to maturity, liquidity risk is not a concern. In this sense, RMB bonds are good for conservative Hong Kongers who are seeking for a good saving instrument, but may not be suitable for investors with actively managed portfolios.

Interest Rate Risk
Buoyant China economy, untamed inflation and relatively low deposit rate uphold an ongoing concern for the interest rate risk of RMB bonds. However, mainland and Hong Kong bond markets are independent, adding that the maturity of the latest issues are rather short term, the sensitivity of the bond price to the Mainland interest rate should be low.

To conclude, on the risk front, investors should pay particular attentions to the currency risk and liquidity risk. The liquidity risk is negligible for those investors who want to hold until maturity.

Hong Konger's Dilemma
When Hong Kong dollar keeps depreciating against RMB, purchasing power of Hong Kongers is weakening accordingly. Therefore, nowadays, every Hong Konger is confronting a huge dilemma: Which currency should I hold as saving deposit, Hong Kong dollar or RMB? As Hong Kong dollar is unlikely to change the dollar peg to RMB in near-term, holding RMB as saving deposits is a better way for purchasing power preservation. Since the coupon rate of RMB bonds is much more attractive than the saving rate for RMB savings (around 0.5 percent per annum), RMB bonds are a good choice for RMB supporters.

Bond fund investors should note that it is inappropriate to compare between RMB bond and any fixed income portfolios, as a single bond holding is far from comparable to a portfolio in terms of risk control. In short, a RMB bond is not a substitute to an Asian bond portfolio.

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About Author

YT Kum, CFA  YT Kum is a consultant for Morningstar, contributing to manager selection and asset allocation activities in Asia, and is responsible for providing investment thought leadership on topics relevent to investors in Asia.  

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