Malaysia Government Securities (MGS) starting to look attractive

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MGS starting to look attractive
By Billy Toh / The Edge Financial Daily   | November 21, 2016 : 8:30 AM MYT   
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Trump’s surprise win has reversed the hunt for yield and put Malaysia in a vulnerable position with its high foreign ownership of Malaysian government bonds. Photo by Reuters

Trump’s surprise win has reversed the hunt for yield and put Malaysia in a vulnerable position with its high foreign ownership of Malaysian government bonds. Photo by Reuters

Trump’s surprise win has reversed the hunt for yield and put Malaysia in a vulnerable position with its high foreign ownership of Malaysian government bonds. Photo by Reuters
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This article first appeared in The Edge Financial Daily, on November 21, 2016.
 

KUALA LUMPUR: The local bond market, which has been rocked by a global sell-off that has wiped out more than US$1 trillion (RM4.42 trillion) worldwide on expectations of higher inflation under a Trump presidency, is starting to look attractive, analysts and fund managers said.

Last Friday, the yield on the benchmark five-year Malaysian Government Securities (MGS) jumped significantly to a one-year high of 4.064%, which is 60.4 basis points (bps) higher than its average five-year yield of 3.46%. It is also 75.8 bps higher than the five-year MGS’ yield of 3.306% on Nov 9, a day after the US election.

The 10-year MGS also increased by 72.3 bps post-US election to its one-year high of 4.395%.

Fixed income research houses viewed the attractive yield as a window of opportunity for long-term investors but warned that the foreign sell-off might continue until the end of this year.

In October this year, foreign holdings of MGS increased by RM2.4 billion to RM240.9 billion, representing 20.8% of total local debt outstanding and the percentage of foreign shareholding of MGS touched a new high of 51.9% from 51.3% the previous month.

The value in foreign holding of Malaysian government investment issue (MGII) also went up to RM30.3 billion in October, or about 12.6% of total MGII outstanding, its highest level since January 2006.

Trump’s surprise win has reversed the hunt for yield — one of the dominant themes in global markets in recent years — and put Malaysia in a vulnerable position with its high foreign ownership of Malaysian government bonds.

Winson Phoon, fixed income analyst at Maybank Investment Bank, shared that the recent volatility in both the ringgit and bond market has hurt sentiment and expected the upward pressure on yields to last until end of the year.

“This round of foreign-led bond sell-offs was substantial and the pace of yield correction is faster than any of the last sell-offs since the Taper Tantrum as foreign positioning or holding level in MGS was at an unprecedented high.

“Looking past volatilities, we are constructive on the medium-term prospect of local government bonds [next three to nine months] and bond yields to retrace lower, but current weakness is not expected to go away anytime soon and to last until at least end of the year,” Phoon said.

He added that for domestic real-money investors with structural demand and a medium- to long-term investment horizon, the current attractive yield represents a great opportunity.

UOB Asset Management (M) Bhd chief executive officer, Lim Suet Ling, also told The Edge Financial Daily via email that the bond rout in the local market was spooked by a surprise Trump presidency.

“His expansionary US fiscal policy is viewed to be inflationary. All these led to steepening of US treasury yield curve, weakening of emerging market currencies, including the ringgit,” Lim said.

She added that the expectations of higher rates triggered heavy foreign selling of MGS, sending yields surging by about 30 bps to 77 bps after the US election.

“Bond yields at current levels are starting to look attractive. We view this as a good opportunity for long-term investors to start nibbling,” she said.

A fixed income trader with an insurance company shared that the risk of foreign outflow is still there especially with a weakening ringgit.

“The value is definitely there if you look at the yield. In comparison with the yield of 3.452% at the end of last year, the yield is higher at 3.974% now although we had an OPR (overnight policy rate) cut this year,” he said.

He added that the US Federal Reserve’s imminent rate hike is likely to have been priced into the market.

Another head of investment with a local fund house shared that Malaysia’s economic fundamentals remain intact despite the foreign sell-off of MGS and MGII.

“I think it is an opportunity. The MGS yield in the short term is very attractive now. There may be local funds who are eyeing for the higher-yield, low-risk MGS during this period,” he said

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Saturday, 7 January 2017
Return of foreign investors’ appetite for bonds?
BY FINTAN NG







 Risk assessment: Analysts believe there are reasons to be cautious on the currency risks, given the ringgit’s movements in recent months.
Risk assessment: Analysts believe there are reasons to be cautious on the currency risks, given the ringgit’s movements in recent months.
 
Yield gap with US treasuries will drive demand

IT seems a stretch to even think that government bond issuances can impact ordinary citizens but it does. Most people will not even know when governments issue bonds but they are issued to raise money for spending, which can be for development or working capital.

In Malaysia, working capital includes civil service salaries and pensions as well as government procurement of supplies and services, areas that come under the operating expenditure of the budget. Development expenditure refers to spending on civil infrastructure such as roads, utilities and ports, defence, education and training as well as affordable housing. In short, government bonds fund working capital through the operating expenditure, without which citizens will be left without a host of government services.

Malaysia has a total of RM67bil in Malaysian Government Securities (MGS) and Government Investment Issue (GII) maturing this year. The gross issuance of government bonds, as these MGS and GII are also known as, for this year will come to RM107bil, including rollover of the bonds that are maturing. This means that if the entire RM67bil of government bonds are to be rolled over or refinanced, the net bond issuance this year will come to around RM40bil.



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The question is how new issuances and the rollover of the maturing bonds will be received by the capital markets given the challenges the economy is facing, both in the domestic and external fronts. Will foreign investors, who have substantial holdings of government bonds, continue to buy or will they continue to invest in the US markets, where the US Federal Reserve has signalled that there could be three more interest-rate hikes this year?

At its most basic, bonds issued by governments or corporations are rated for their credit risk by the strength of the underlying cash flow, which gives a fair idea of a country’s economic growth or a company’s financial health. Malaysia has a A rating and a stable outlook.

There are other risk assessments too at the country level, including for currency, inflation and politics. Analysts believe there are reasons to be cautious on the currency risks, given the ringgit’s movements in recent months and, political risks, given that a general election may be called this year.

If there is no reason to doubt the finances of a government or company, then international rating agencies such as Standard & Poor’s (S&P), Moody’s and Fitch or local ones such as RAM Holdings Bhd or Malaysian Rating Corp Bhd will rate these entities with a higher credit rating, the higher the rating the less reason to be concerned that the Government or company will default.



The ability of the Government to honour the periodic interests from the bonds and pay the principal really depends on how well and how much tax it can collect. Being fiscally prudent is good too. Also, it helps if the economy is growing at a healthy pace because incomes at the individual and corporate levels will be higher, which means more taxes can be collected. Higher personal incomes mean more spending in the domestic economy, which means more government revenue coming from the goods and services tax.

However, economic growth has been slowing since 2014 and the picture this year is not much better. The International Monetary Fund projects the Malaysian economy to grow 4.5% this year, better than last year but still slower than 2015 and 2014. The Government projects 4% to 4.5%, so growth will be flat this year when compared with last year, which has been projected at 4.2%. While oil prices have risen on production cuts, demand is still uncertain because the global economic outlook remains cloudy.

What this means is that the ability of the Government to spend on all aspects of the economy and society will be constrained, partly because it will collect less tax but also because it wants to lower the fiscal deficit, targeted at 3% of gross domestic product or RM40.3bil for this year, from 3.1% last year. It has recalibrated the federal budget twice, in fiscal 2015 and 2016, to reflect the lower oil prices and to reprioritise spending.

Also, there will be pressure from foreign investors accelerating their selling of MGS/GII should the prospects of the economy remain dim. Yields will climb as bond prices fall, which will mean more funds will have to be allocated from the operating expenditure to service debt, already projected to increase to 9.7% or RM26.6bil last year from 7.5% or RM24.3bil in 2015.

Double-edged sword

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Double-edged sword

Foreign investors still have substantial holdings of MGS and GII despite the selldown of government bonds since the US presidential election. Having foreigners hold so much Malaysian debt is not a good thing, despite their confidence in the economy and the ability of the Govern-ment to honour bond payments.

This means that government bonds are at risk of being sold off even more, which will contribute to more ringgit volatility. The ringgit’s weakness in recent weeks have largely been due to foreign investors selling down their holdings of MGS and GII. This also means that Malaysian bond prices have fallen and in tandem with that, yields have risen, with the benchmark 10-year MGS now at 4.230%. It spiked to 4.463% at the end of November from the low of 3.471% in mid-August.

Corporate bonds, which tend to track the 10-year MGS, have also seen their yields rise. Notably, there have been downgrades in credit ratings for certain industries such as the oil and gas, plantation and automotives.

A bond trader tells StarBizWeek that several factors constrain how foreign investors view the issuances this year. “There is uncertainty as to the real value of the ringgit versus the US dollar,” he says, adding that Bank Negara will have to address their concerns over the ringgit’s value.



The central bank’s role will be crucial given that it is the only market maker, that is, the only provider of liquidity, in the foreign-exchange market. “Effectively the bond market is affected by the exchange rate, and Bank Negara should focus on the bond market,” he says. The central bank had prohibited fixing the price of the US dollar-ringgit spot rate in the non-deliverable forward or offshore market to stem ringgit volatility.

He says another factor is that the trickle down effect from the requirement of exporters to convert 75% of their proceeds into ringgit has been slow. “It has not really have an impact in the foreign reserves,” he says. The requirement was implemented in early December but due to ringgit weakness, foreign reserves have fallen to US$94.6bil as at Dec 30 compared with US$96.4bil on Dec 15.

He points out that how the central bank treats several offshore banks who have ringgit valued at US$8bil to US$10bil held in Malaysian banks that they want converted to greenbacks will be crucial in instilling confidence. “Until all these issues are addressed, there’ll continue to be a sell down in government bonds,” he says.

He says fewer Malaysian government bonds in the market could be a good thing. “It means less spending, in line with the commitment to pare down the fiscal deficit,” he says. Fewer Malaysian government bonds in the market will also drive demand, and this will support bond prices while lowering the yield, releasing pressure to make high payouts.



But less MGS or GII in the market could also mean institutional funds, and in particular those with mandates to invest in at least A-rated government bonds, have fewer opportunities to invest. CIMB Investment Bank Bhd’s regional fixed income research director Nik Ahmad Mukharriz Nik Muhammad says fewer MGS or GII issuances in the market will impact demand and liquidity in the bond market, where funds view MGS and GII as one of the most important components of their portfolio that is supported by increasingly attractive yields and the notion of the Government as a safe borrower.

However, he expects foreign investor appetite to return because of attractive yields as the selldown since November have come about because of the high foreign holdings and selldowns of Malaysian government bonds were also seen in 2013 following the US Federal Reserve’s decision to buy less bonds and during the 2008 global financial crisis.

Nik Ahmad Mukharriz says barring any major market shocks, foreign investors should still be interested in the Malaysian debt up for refinancing this year. Forecasting yields to rise sharply in the medium-term, he says investors will still be attracted by the spread between MGS/GII over US dollar assets, which is wider than 170 basis points.

“This is pretty attractive for an A- rated country vis-à-vis other and lower rated emerging market assets,” Nik Ahmad Mukharriz says.

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