Pimco, others big buyers of this red-hot asset class

Yuan-denominated instruments seen as much better bet than G-3 investments; 'limited supplies' add to luster

Apr 19, 2011 @ 12:47 pm

Pacific Investment Management Co. and other investors are boosting holdings of yuan-denominated assets as debt crises worsen in the U.S., Europe and Japan.

Pimco has a “favorable view of the yuan,” London-based fund manager Maria Gordon said April 14, less than a week after founder Bill Gross said he bet against Treasuries in March because of the U.S. budget deficit and risk of accelerating inflation. Shin Kong Life Insurance Co., Taiwan's second-largest life insurer, said it may cut holdings of U.S. debt and is seeking an investment quota for Chinese assets.

Standard & Poor's cut the outlook on its AAA rating for the U.S. to “negative” from “stable” two days ago, yields on Greece's two-year notes exceeded 20 percent and Moody's Investors Service said last month that Japan may reach a fiscal “tipping point.” The yuan will rise 3.7 percent versus the dollar by the end of the year as policy makers allow appreciation to curb inflation, the biggest gain in Bloomberg analyst surveys covering 22 emerging-market currencies.

“Chinese policy makers are well ahead of the curve” on inflation and keen to avoid the pitfalls that derailed growth in the world's biggest developed economies, Chia-Liang Lian, head of emerging Asia at Pimco, said yesterday at a press briefing in Hong Kong. “What Chinese policy makers have learnt is: Don't wait for the problem to happen.”

Fund Results

Pimco manages about $200 billion in emerging-market debt and said last week it hired Isaac Meng, formerly a Beijing-based economist at BNP Paribas SA, as a money manager in its Hong Kong office. Gordon, who joined last year, told Bloomberg Television the Pimco EqS Emerging Markets Fund of shares she oversees has a “large overweight in China.”

The $6.9 billion Pimco Emerging Local Bond Fund returned 3.7 percent this year to beat 78 percent of similarly managed rivals, according to data compiled by Bloomberg. U.S. government debt gained 0.5 percent, based on Bank of America Merrill Lynch's Treasury Master index. The securities “have little value,” Gross wrote in his April investment outlook.

China's local-currency debt advanced 2.1 percent in dollar terms, according to an index compiled by JPMorgan Chase & Co. Yuan-denominated debt listed in Hong Kong, so-called dim sum bonds, returned 3.1 percent, according to the HSBC Offshore Renminbi Bond Index.

‘Better Investment'

“China is definitely a better investment option than the U.S. given the economic outlook and its more stable fiscal situation,” said Zeal Yin, who buys Treasuries for Shin Kong Life Insurance, which has the equivalent of $50.6 billion in assets. “The huge budget deficit facing the U.S. is worrying. If the situation doesn't improve, we'll have to consider selling our U.S. government bonds and invest in something else.”

The U.S. budget deficit is projected to top $1.6 trillion this year, or 10.9 percent of gross domestic product, and President Barack Obama is negotiating with Congress to raise the government's $14.29 trillion legal debt limit.

Japan's debt is set to reach 210 percent of GDP in 2012, the highest among countries tracked by the Organization for Economic Cooperation and Development, and governments in Greece, Ireland and Portugal have accepted European Union-led bailouts in the past year.

“Selective emerging markets with sound macroeconomic policies and higher yields in Asia outside Japan stand to benefit from the increased downgrade risk to G-3 economies,” said Ray Choy, head of debt-market research at RHB Research Institute in Kuala Lumpur. “Hence, capital flows would benefit well-managed economies in emerging markets and in Asia outside Japan. These would include China.”

Dollar Slide

The dollar weakened against nine of Asia's 10 most-used currencies in 2010 and Choy predicts there will be “greater downward pressure” this year and next, heightening the risk that Treasury yields will climb. The yuan strengthened 3.6 percent in 2010, and has risen a further 1 percent since December.

China's currency reached 6.5276 per dollar on April 18, the strongest level since 1993, and yesterday slipped 0.03 percent to 6.5305 in Shanghai. Twelve-month non-deliverable forwards traded at 6.3715, a 2.5 percent premium to the spot rate.

The allure of a strengthening currency and economic growth that's averaged 10 percent for a decade are attracting funds to China.

Foreign Investment

Foreign direct investment into China jumped 33 percent to $12.5 billion last month from a year earlier, the commerce ministry said yesterday. Foreign-exchange reserves climbed $197 billion in the last three months to a record $3 trillion, even as the nation had its first quarterly trade deficit in seven years.

The flood of cash has helped drive the yield on one-year government debt down 45 basis points, or 0.45 percentage point, to 2.83 percent in 2011 even as policy makers boosted benchmark one-year lending and deposit rates by half a percentage point and increased lenders' reserve-requirement ratios four times. Similar-maturity bills yield 12.51 percent in Brazil and 7.60 percent in India.

China's foreign-exchange reserves have exceeded a “reasonable” level and are putting pressure on central-bank operations that withdraw money from the financial system, central bank Governor Zhou Xiaochuan said April 18. “The build- up could cause big risks,” he said, without elaborating.

Growing Economy

The world's second-biggest economy grew 9.7 percent in the first quarter from a year earlier, faster than economists forecast, and consumer prices climbed 5.4 percent in March, data showed last week. The People's Bank of China plans to increase the yuan's flexibility to cut the cost of imports and counter inflation, Deputy Governor Hu Xiaolian was cited as saying in a speech posted yesterday on the central bank's website.

The central bank kept the yield on one-year bills unchanged yesterday at 3.3058 percent at a weekly auction that raised 55 billion yuan. The finance ministry will sell 30 billion yuan of three-year bonds today at 3.18 percent, according to the median estimate of finance companies surveyed by Bloomberg News.

The one-year deposit rate at commercial banks is 3.25 percent, while the average yield on dim sum debt is 1.92 percent, according to the HSBC index.

Overseas investors are free to invest in Hong Kong's offshore market for yuan-denominated assets, though they need investment quotas to invest in onshore securities.

“There's a big global demand for yuan assets but there are limited supplies out there,” said Ivan Leung, chief investment strategist in Hong Kong at JPMorgan Private Bank, which oversees $600 billion in assets. “Yields are low but if you combine interest rates and currency appreciation it actually looks very attractive.”

Five-year credit-default swaps on China's dollar- denominated sovereign bonds rose 1 basis point yesterday to 74.5 basis points in London, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The contracts insure debt against non-payment, and traders use them to speculate on credit quality. An increase suggests deteriorating perceptions of creditworthiness and a drop shows improvement.

--Bloomberg News--


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