Known for its volatile stock market and its role as a gateway to China, Hong Kong has been quietly developing a high-quality bond market in Asia. Now, a window of opportunity has opened for investors seeking safe havens.
By Terrence Pang, Portfolio Manager, Lawrence Yu, Managing Partner, and Noah Sin, Investment Editor
Terrence Pang
Hong Kong’s low-key bonds are flourishing. Often overshadowed by the city’s much larger stock market, Hong Kong’s bond market has expanded 60% since 2015, representing faster growth than most of its Asian counterparts last year. While still smaller than its regional rival Singapore and several other less stable Asian markets, the bond market is displaying positive momentum among the competition. A number of companies have recently returned to Hong Kong to issue new bonds in private placements – fresh from public market refinancing deals – in response to strong investor demand.
Lawrence Yu
This demand is partly driven by the correlation between Hong Kong and US bonds. Given the long-standing peg of the Hong Kong dollar to the US dollar, policy rates in the region – and consequently bond yields – largely mirror trends in the US (although Hong Kong bonds are scarcer and, therefore, slightly more expensive, resulting in lower yields). As the US Federal Reserve moves closer to easing, Hong Kong bonds, similar to US securities, should rally.
However, Hong Kong bonds now offer an added advantage. With a hedge once morest the US dollar, they have been offering higher yields than US Treasuries for several quarters – a relatively recent phenomenon. What has changed?
Noah Sin
The answer lies in the subtleties of Hong Kong’s monetary regime. Despite the peg, Hong Kong’s monetary policy has lagged the US for multiple successive policy cycles (both tightening and easing). For example, banks can lock in mortgage or deposit rates if they believe US developments are unfavorable to their business. These compressed rates have contributed to a decline in interbank liquidity in the region as brokers have shifted away from Hong Kong to higher US rates, a phenomenon exacerbated by a weak local stock market (suggesting lower demand for Hong Kong dollars). As a result, the HKD-USD hedge fee, which is supposed to reflect the interest rate differential between the two markets, has risen, pushing the spread between Hong Kong’s 10-year yields (for hedged securities) and US Treasuries beyond a comfortable threshold.
Hong Kong has more to offer bond investors than just the spread suggests. It is one of the few Asian markets, outside Japan, that have an AA rating and no restrictions on capital flows. The government, the largest borrower, holds significant reserves (nearly 25% of GDP). Even the secondary issuers are highly reputable, including large financial institutions and local companies such as MTR, the metro operating company, and the Airport Authority.
In multi-asset portfolios, Hong Kong bonds’ mild correlation to Asian risk (stocks and high-yield bonds outside Japan) provides valuable diversification during uncertain times. With the help of a slight bump once morest US Treasuries, Hong Kong bonds might finally receive the attention they deserve.
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Fidelity offers financial services that constitute acquisitions and/or disposals of financial instruments within the meaning of the Swiss Financial Services Act (FinSA). Fidelity is not required to verify the suitability and adequacy of the financial services it provides under the FinSA. Any investment must be made on the basis of the current prospectus and the FIB (Basic Information Sheet), which are available free of charge, as are the articles of association and the latest annual and semi-annual reports of our distributors, from our European Service Center in Luxembourg, FIL (Luxembourg) SA, 2a rue Albert Borschette BP 2174 L-1021 Luxembourg, or from our Swiss representative and payment service, BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich. This promotional material is issued by FIL Investment Switzerland AG. The information contained in this promotional material should not be understood as an offer or an invitation to make an offer to acquire or dispose of the financial products mentioned in this promotional material.
Known for its frenzied stock market movements and its role as a conduit to China, Hong Kong has been quietly building a quality bond market in Asia. And now a window has opened for investors looking to seek refuge there.
By Terrence Pang, Portfolio Manager, Lawrence Yu, Managing Partner, and Noah Sin, Investment Editor
Terrence Pang
Hong Kong’s Underappreciated Bond Market
Hong Kong’s low-profile bonds are thriving. Often overshadowed by the metropolis’s much larger stock market, Hong Kong’s bond market has expanded 60% since 2015[1], representing faster growth than most of its Asian counterparts last year.[2]. While still smaller than regional rival Singapore and several other less solvent Asian markets, the bond market is showing some good momentum among the competition. A handful of companies have recently returned to Hong Kong to issue new bonds in private placements – fresh from public market refinancing deals – in response to strong investor demand.
Lawrence Yu
Yield Advantages and the Hong Kong Dollar’s Peg to the USD
This demand is driven in part by the correlation between Hong Kong and US bonds. Given the long-standing peg of the Hong Kong dollar to the US dollar, policy rates in the region – and, in turn, bond yields – largely mirror trends in the US (although Hong Kong bonds are scarcer and, therefore, slightly more expensive, which translates into lower yields). As the US Federal Reserve moves closer to easing, Hong Kong bonds, like US securities, should rally.
Now, however, Hong Kong bonds have an added benefit. With a hedge to US dollars, they have been offering higher yields than US Treasuries for several quarters – a relatively recent anomaly. What has changed?
Noah Sin
Lagging Monetary Policy and Interbank Liquidity
The answer lies in the nuances of Hong Kong’s monetary regime. Despite the peg, Hong Kong’s monetary policy has lagged the US for multiple successive policy cycles (both tightening and easing). For example, banks can lock in mortgage or deposit rates if they believe developments in the US are unfavourable to their business. The compressed rates have helped to dry up interbank liquidity in the region as brokers have shifted away from Hong Kong to higher US rates, a phenomenon exacerbated by a weak local stock market (implying lower demand for Hong Kong dollars). As a result, the HKD-USD hedge fee, which is supposed to reflect the interest rate differential between the two markets, has increased, pushing the spread between Hong Kong’s 10-year yields (for the hedged securities) and US Treasuries beyond a comfortable threshold.
Strengths of the Hong Kong Bond Market
Hong Kong has more going for it than the spread suggests for bond investors. It is one of a small number of Asian markets, outside Japan, that are AA-rated and have no restrictions on capital flows. The government, which is the largest borrower, has huge reserves (nearly 25% of GDP).[3] Even the secondary issuers are full of qualities, being large financial institutions and reputable local companies, such as MTR, the metro operating company, and the Airport Authority.
Diversification Benefits and Considerations for Investors
In multi-asset portfolios, Hong Kong bonds’ mild correlation to Asian risk (stocks and high-yield bonds outside Japan) is useful for diversification in uncertain times. With the help of a small bump once morest US Treasuries, Hong Kong bonds might finally get some much-needed attention.
Fidelity offers financial services that constitute acquisitions and/or disposals of financial instruments within the meaning of the Swiss Financial Services Act (FinSA). Fidelity is not required to verify the suitability and adequacy of the financial services it provides under the FinSA. Any investment must be made on the basis of the current prospectus and the FIB (Basic Information Sheet), which are available free of charge, as are the articles of association and the latest annual and semi-annual reports of our distributors, from our European Service Center in Luxembourg, FIL (Luxembourg) SA, 2a rue Albert Borschette BP 2174 L-1021 Luxembourg, or from our Swiss representative and payment service, BNP Paribas Securities Services, Paris, succursale de Zurich, Selnaustrasse 16, 8002 Zurich. This promotional material is issued by FIL Investment Switzerland AG. The information contained in this promotional material should not be understood as an offer or an invitation to make an offer to acquire or dispose of the financial products mentioned in this promotional material.
