Eastspring Investments focuses on local corporate bonds

WITH the US elections and China's much awaited leadership change now out of the way, retail investors in Singapore are raring to return to the market in the lead up to the year-end holiday season, which is often also the time when many look to rebalance their portfolios. "Singapore investors have traditionally been underweight in bonds," says Danny Tan, assistant director (fixed income) at Eastspring Investments Singapore. In the current choppy investment climate with the looming fiscal cliff in the US and concerns about the eurozone breakup, putting a little more savings into bonds might actually be a smarter strategy than chasing more risky assets.

Tan, a graduate of Nanyang Technological University, manages among other funds, Eastspring Investments' Singapore Select Bond Fund, which has grown to more than S$190 million since it was set up 18 months ago. The fund is up more than 11.2% since its launch and 5.7% against its benchmark, the HSBC Singapore Local Currency All Bond Index, over the past 12 months. Eastspring Investments, the Asian asset management arm of UK insurance giant Prudential plc, is one of the largest fund managers in Singapore, with nearly S$75 billion in funds under management. Eastspring's fixed income teams in Asia have US$18 billion worth of assets under management in the region.

The fund invests in a mix of Singapore government bonds and local corporate bonds such as those from CapitaLand and DBS, which have been yielding close to 4% recently. Why should local investors be in bonds now, and why in Singapore bonds? For one thing, Singapore-dollar bonds are lower-beta investment products than even a portfolio stacked with top-notch Asian dollar bonds. Moreover, the Monetary Authority of Singapore's (MAS) support of a strong local currency provides technical support for Singapore bonds.

Indeed, with ratings agencies downgrading even some of the world's largest economies over the past year, Singapore is now one of the few markets that offers an AAA rating. "We believe that US interest rates are likely to remain low for an extended period of time, at least for the next two years, possibly longer, and despite higher inflation, Singapore rates are likely to be driven more by movement of rates in the US," says Tan. "We think Singapore corporate bonds are still offering fairly decent rates of returns compared with other asset classes," he notes. "If you are a retail investor in Singapore, you really get nothing from putting your savings in a bank deposit." Singapore deposit rates have been low for a decade now, he notes.

Until now, Singapore investors had piled into safer local or regional bond funds that invest primarily in government securities or quasi-sovereign bonds such as those issued by statutory boards in Singapore. Increasingly, more fund houses such as Eastspring are offering funds that target better-yielding corporate bonds. "We thought there was a need for a bond fund that could take advantage of a growing number of corporate bonds, that were giving decent yields, and match it with retail investors searching for better yields," says Tan.

Clearly, local corporate bond funds are hitting a sweet spot. Fixed income securities are becoming an important asset class owing to demographic reasons. "We have an ageing population in Singapore and as time goes by, more investors want decent recurring income," says Tan. Increasingly, investors in more developed Asian economies such as Singapore, Taiwan, South Korea and Hong Kong are looking at better income planning through investments that generate yields that are far higher than inflation. While products such as real estate investment trusts (REITs) have done well for Singapore investors, investors realise they may not perform as well in a climate where property prices and rents are not rising as fast as over the past few years, says Tan.

To be sure, corporate bonds in Singapore yield an average of 3% to 4%, largely driven by credit spreads in the country. There are also bonds issued by local REITS such as Mapletree Commercial Trust, which have even better yields. "There is no shortage of good Singapore corporate bonds in the current climate," notes Tan.

His fund also has a good sprinkling of the controversial fixed-income "perpetual securities" that many local corporates have resorted to in their attempts to raise capital over the past year. "While there have been investor warnings from MAS on the complexity of perpetual securities, we feel that a fixed-income portfolio that has a small portion invested in such securities actually represents a good deal for investors," declares Tan. Some of the perpetual securities yield between 4.5% and 5.5%, he notes.  While investing in such securities might be risky for individual investors, Tan says "on a blended basis, they add value to a bond fund", which in turn is probably just a part of most investors' broader portfolio.

A big concern for local bond investors has been Singapore's sticky inflation. If global rates stay high and Singapore is unable to fight inflation with other tools such as exchange rates, MAS might allow interest rates to edge up at some point and that would be disastrous for bonds, or so the thinking goes. Tan doesn't believe the sticky inflation will spook local bond investors. "Food prices have been moderating across the region, so the real drivers of Singapore inflation have been high housing prices and high transportation or prices of COEs [Certificates of Entitlement]," he says. The way he sees it, even a slightly higher inflation won't lead to a spike in local rates.

So, what sort of return can local bond fund investors look forward to? Eastspring's Singapore Select Bond Fund is up nearly 6% over the past year. Historically, Singapore corporate bonds have given investors up to 2% return above inflation. In the aftermath of the recent bond rally following the third round of quantitative easing in the US, Singapore bonds may not be as attractive as they were some months ago but they still provide a good mixture of protection and decent returns for long-term investors, says Tan.

Right now, 70% of the fund is in corporate bonds and 30% in Singapore government securities. The fund can invest up to 30% in non-Singapore bonds, bonds issued by companies in the region or bonds denominated in foreign currencies. "We do buy foreign currency bonds issued by Singapore entities and some by Asia-Pacific corporates but we hedge them to the Singapore dollar, so there is no foreign exchange risk," says Tan. Non-Singapore bonds make up 20% of his bond fund's portfolio. Among the names are Hong Kong property giant Cheung Kong Holdings and Australian financial group LendLease.  The fund also prefers the capital securities of Australian banks such as Commonwealth Bank, which were yielding 5.5% when he bought them some months ago.

Tan defines "corporate bonds" in Singapore fairly broadly. For him, quasi-government bonds such as those issued by the Housing Development Board should be seen as corporate bonds rather than sovereigns. "They are priced like corporate bonds rather than government securities, so we look at them as corporate bonds." Tan's portfolio has DBS, NTUC Income Insurance, CapitaLand and OCBC bonds as well as those issued by REITs such as Mapletree Commercial Trust and Mapletree Industrial Trust. Indeed, nearly two-thirds of his portfolio is essentially government bonds, quasi-government bonds and bonds of Temasek-linked companies.

Why is there a portion in foreign bonds if the case for local bonds is so strong? "The yields in the US dollar space are fairly attractive and the hedging cost is small," he explains. "If I can get a good US dollar bond yielding 4% and my hedging costs 50 to 70bps, I still have a return of 3.3% to 3.5%."

Aside from foreign bonds, 5% of the fund is invested in convertible bonds, which gives investors bond yields but with equity upside on conversion. "As a bond fund, we are buying convertibles for the yield and are really not looking to convert them to equities," says Tan. If the bond is converted, the fund immediately sells the equities on the market. Among the convertible bonds in his portfolio are those from CapitaLand, Keppel Land and CapitaMall Trust.

This story first appeared in The Edge Singapore weekly edition of Nov 12-18, 2012.

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