BENCHMARK (BM): How did BOCHK Asset Management decide to invest in triple A rated bonds issued by the World Bank’s members to develop the BOCHK – World Bank Emerging Markets Bond Fund?
Dr. King Au (KA): One of the risks associated with bond investments is the risk of default. Bonds in emerging markets tend to offer higher interest rates, but there is also a higher risk of default and such bonds are more volatile. Yet, the benefit of choosing bonds issued by the World Bank1 in local currency is that the credit rating of the World Bank is AAA (by Standard and Poor’s), i.e. the highest rating, implying that the risk of default is at its lowest. The other risks involved in bond investments in emerging markets include restricted access to local capital markets and required tax payments, such as the inflow tax and withholding tax. However, the World Bank’s bonds do not have such restrictions and taxes.
BM: Why does the fund’s investment strategy focus on the trading partners of mainland China?
KA: Now China is the world’s second largest economy. As a key driver of the global economy, China’s economic growth has a significant impact on the macroeconomic landscape, while bringing new investment oppor tuni t ies. We possess sound knowledge of the mainland market and have an experienced team of professionals in international bond market investments. With this unique competitive edge, we designed a fund that encompasses both the China theme and investments across the globe.
Most of the funds in the market focus on either emerging markets or developed markets. In view of this, we have adopted a brand new approach by selecting countries that are beneficiaries of the mainland’s economic boom, namely, those who are the mainland’s trading partners. These include both emerging market countries, such as Mexico, India and Poland, and commodity countries, such as Australia, New Zealand and Norway.
The fund is a diversified portfolio with at least 85% of its net asset value (NAV) invested in World Bank issued bonds denominated in the currencies of emerging market countries who are trading partners of mainland China, and/or in the currencies of commodity producing countries. The fund is allowed to invest up to 15% of its NAV in US Treasury bonds, offshore RMB-denominated bonds issued by the PRC government and/or cash. This enables the fund to have greater flexibility in looking for investment opportunities and managing risks.
BM: On the socially responsible investment side, was there an intention to help reduce pover ty through your investments in developing countries? Were environmental, social and governance factors taken into account during the underlying bonds selection?
KA: The fund doesn’ t have such restrictions. The World Bank is a global leader in promoting SRI and ESG. We share this common tenet with the World Bank.
BM: How does the fund manage underlying risks?
KA: The Wor ld Bank ’s bonds have received the highest possible bond rating from Standard & Poor’s. As such, the risk of default is low. However, there are still other risks, namely currency risk and interest rate risk. In this vein, we undergo well-established and comprehensive inhouse investment processes for currency and interest rate investments. Different quantitative and qualitative tools are applied and fundamental, as well as technical factors are thoroughly considered before an investment decision is made. Our investment team has an open culture. All team members are welcome to bring in new perspectives or opposite views in all investment discussions.
BM: With mainland China’s economy slowing, what impact will this have on sectors, such as iron and gold? Why do you favor oil and energy exporting countries?
KA: Despite the slowdown of economic growth in China, the mainland’s economic growth reached 7.7% in 2013, which was still relatively strong as compared to other economies. The growth in individual sectors, such as in the heavy manufacturing industry is expected to slow down, which will likely affect the import of metals, such as gold, silver, copper, iron, tin and aluminum. China is a major importer of these metals, accounting for 30%-50% of the world’s total production. However, its usage of crude oil only amounts to about 10% of the world’s total. With an expanding middle class in China, the demand for crude oil will continue to rise, which is positive news for oil-producing countries.
BM: The fund has significant allocations in Mexico and Sweden. Why did you choose the Mexican Peso and Swedish Krone?
KA: We are optimistic about Mexico because of the country’s significantly improved governance. The progress of economic reforms in Mexico’s labor market and energy industry are meaningfully improving the country’s productivity. In addition, its inflationary pressures are now coming under control. As the energy sector of Mexico is being opened up for foreign investments, its oil and gas production and exports are bound to increase to boost the Mexican peso. As for Sweden, we have already taken profit, and we currently do not hold relevant bonds and currencies.
As of the end of February 2014, more than 30% of the fund’s holdings were Norwegian krone denominated bonds issued by the World Bank. Norway is an oil exporting country and thus the Norwegian krone has benefited f rom strong domestic consumption and rising ownership of cars in China. Increasing oil demand from China is supportive of global oil prices.
In addition, more than 25% of the fund’s holdings are assets denominated in the New Zealand dollar. The economy of New Zealand is robust with growing pressure to hike interest rates, while China has been increasing its dairy imports from New Zealand due to rising domestic consumption. All of these will contribute to the potential appreciation of the New Zealand dollar.
BM: How does the team allocate across the fixed-income spectrum, including emerging markets debt, government bonds and local currency?
KA: Our in-house currency and interest rate investment frameworks allow us to gauge relative values of currencies and interest rates across different countries in the world. We take long-term fundamental factors, medium-term cyclical variables and short-term market technical forces into consideration. The fund’s asset allocation is on a global basis with special attention to controlling tail risk. Hence, we successfully controlled volatility risk due to our timely switch to a defensive strategy in April 2013 ahead of emerging markets currencies’ sell-offs in May 2013. We had also cut all positions of more volatile currencies, such as the Brazilian real and Turkish lira before they ran into turmoil. In addition to our econometrics models, our savvy analysis of geopolitics has played an important role in our country allocation.
BM: What is your duration strategy under the current situation of lack of growth in emerging markets and short-term pessimism on global growth? KA: Our economic analysis indicates divergent inflation outlooks across countries. We expect declining inflation rates in countries, such as China and Mexico, with strong momentum of economic reforms.
We also expect that countries with close economic ties with the euro zone, such as Norway, will import deflationary pressures from the euro zone. Hence, we are looking for opportunities to increase duration exposures to these countries. In contrast, we will maintain a minimum duration exposure to New Zealand, as we expect more interest rate hikes in the country due to its serious economic bottlenecks.
BM: Are sharp declines in EM local currencies and a rising rate environment concerns going into 2014? What is your outlook for EM?
KA: We expect to see increasing divergence among emerging market countries. Those with positive economic outlooks, such as China, Mexico, Vietnam, Poland and the Czech Republic, have strong economic reform momentum and improving government governance and/or current account surpluses.BM
1. It refers to International Bank for Reconstruction and Development which is commonly referred to as the “World Bank”.