January 27, 2012
Malaysian Bond Market: A Review of 2011 and Outlook for 2012
by iFAST Research Team
Review For 2011
The issuance of Malaysia Government Securities (MGS) amounted to RM93.3 billion in 2011, a significant increase from RM58.1 billion in 2010. This is the highest level since the record issuance achieved in 2009 which amounted to RM88.5 billion. The strong issuance by the government was to fund for the development expenditures under the Economic Transformation Programme (ETP) and also to fund the budget deficit.
Meanwhile, the issuance of Private Debt Securities (PDS), or more commonly known as corporate bonds, declined to RM47.3 billion in 2011 from RM49.6 billion in 2010. The decline was mainly due to the more prudent spending by businesses, and hence the delay in expansion plans caused by the economic uncertainty in 2011. Chart 1 shows the Malaysian bond market issuance for the past 5 years.
Due to the escalating risk aversion and weakening investor sentiments, global equities performed poorly in 2011.With Malaysia being a more resilient market, the FBM KLCI was able to mark a positive return of 4.45% inclusive of dividends for the year (0.8% exclude devidends). Bonds on the other hand did relatively better than the equity market. Both the MGS and PDS indices recorded a return of 4.83% and 7.56% respectively in 2011. The demand for higher yield amidst the low-yielding environment in developed countries has also boosted the performance of the Malaysian bond market (refer to Chart 2).
What To Expect in 2012?
OPR Is Expected to Maintain at 3.0% for Extended Time in 2012…
The BNM has maintained the OPR at 3.0% since the increase in May 2011. This was due to the worry that the external headwinds may cause economic growth in Malaysia to slowdown. Also inflation is seen to have peaked in recent months which gives more room for BNM to pause adjusting the policy rate upward (refer to Chart 3).
Market participants have also priced in this possibility as yields declined across the board since first quarter of 2011 (refer to Chart 4, orange box). For example, the 3-year MGS is trading at a yield of 2.98% as of end-2011, 49 bps lower than the yield of 3.47% on 1 April 2011.
…A Rate Cut if The Economy Slows Down Significantly
While BNM is expected to maintain the OPR at 3.0% for an extended time, we expect the BNM to cut the OPR by 25 - 50 bps in 2012 if Malaysia’s economic growth slows down significantly. When economic indicators such as exports, consumer confidence or business sentiment declines significantly, BNM will most likely cut interest rates. Furthermore, countries like Brazil, Australia, Indonesia and Thailand have cut their respective benchmark interest rates in 2011 on the concern that the global economic slowdown may affect their own economic growth.
Having said that, we expect that the yields of MGS to face further downward pressure from current levels. As such we see the opportunity for investors to enjoy potential capital gains in MGS when yields decline in 2012. Furthermore, the relatively higher MGS yields as compare to ultra-low yields in developed countries’ sovereign debts may also support the investor demand for MGS.
PDS A Better Choice For Higher Risk Appetite Investors…
Although there are still investment opportunities in the MGS space in 2012, investors that are willing to stomach higher risk should consider investing in PDS which provide higher yields than MGS. The yield spread suggests that the PDS are still attractive.
We first look at the yield spread between the 10-year AA rating PDS and the 10-year MGS (refer to Chart 5).
From the chart, we can see that the yield spread of 192 bps as at end-2011, is higher than the pre-2008 crisis yield spread of between 149 bps and 189 bps, which is the range we expect during normal economic conditions (Chart 5, orange box). As such, the current yield spread remains wide and indicates that the 5.609% yield of the 10-year AA rated PDS is attractive.
…Riskier Segment PDS Even More Attractive…
For investors those are able to take much higher risk, PDS with lower-than-AA ratings can be considered as well. The yield spread of the riskier A rated PDS is at a very attractive level (refer to Chart 6).
In Chart 6, we can see that the yield spread is at 504 bps as of end-2011, and is much higher than its 10-year average of 432 bps. The yield spread remains within a higher range since the 2008 financial crisis as investors prefer investments with lower risk like the MGS and higher rated PDS (AAA rating). However, during normal economic conditions, the yield spread should be between 330 bps and 430 bps (Chart 6, orange box). The relatively high yield spread indicated that the 8.733% yield (as of end-2011) of riskier A rated PDS is at a very attractive level as well.
…Potential Capital Gains from Improving Investors’ Sentiment
Furthermore, our in-house outlook for 2012 is that investors’ sentiment is expected to improve, which mean that investors’ risk appetite will increase and tend toward higher yielding riskier assets. Given this, investors will turn their focus to riskier PDS from the low-yielding MGS. This in turn leads us to expect that the yields of PDS will trend downward in 2012 and may give potential capital gains to investors.
2011 was a turbulent year full of uncertainties, and investor risk aversion translated into a relatively better performance for the Malaysian bond market compared to the equity market. In 2012, we expect BNM to maintain OPR at 3.0% for extended time to promote economic growth and also because inflation has peaked.
However, if economic growth deteriorates significantly in 2012, we may see BNM cut rate by 25 - 50 bps. Due to this we expect the MGS yields to face further downwards pressure from their current levels. As such, we see opportunity for capital gains in the MGS space. Furthermore, the relatively higher MGS yields compare to the ultra-low yields in developed countries’ sovereign debts will also support the demand for MGS by investors.
In addition, we recommend investors that have higher risk appetites to consider investing in PDS which provide higher yields compared to MGS. This is because the current widened yield spread suggests that the PDS yields are at an attractive level. Add to that the increasing demand we expect for riskier PDS, we believe that PDS yields will be driven down and hence, giving investors a potential for capital gains in 2012.
Fixed Income Funds To Consider:
Key Investment Themes And 2012 Outlook
|The Research Team is part of iFAST Capital Sdn Bhd|
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