Duration risk is back in vogue - for the time being

By Christopher Langner and Neha D'silva

SINGAPORE, Sept 27 (IFR) - Buyers of Asian bonds are all about duration risk lately. Three transactions from companies in the region this week showed there is plenty of appetite for longer maturities and lower yields.

This marks a significant shift from the position that investors in Asia had throughout most of the summer, a period during which most accounts and traders were trying to reduce their exposure to duration risk.

But three deals this week offered evidence that demand for long-duration securities is back. Duration desribes a bond's price sensitivity to changes in interest rates.

On Tuesday, Thai lender Bangkok Bank issued five-year and 10-year bonds and saw more interest in the longer tenor. Then on Wednesday, Australian miner BHP Billiton (NYSE: BBL - news) printed more bonds in the 30-year portion of its jumbo four-part deal than in the three, five and ten-year parts.

Perhaps the best example of how much duration appetite has increased was Country Garden's offering on Thursday. The Chinese developer returned to the market with a 7.5-year bond that offered a modified duration of 5.71 at pricing, very high for sub-investment grade standards.

In early January, B2/BB rated Country Garden had already taken advantage of the appetite for duration that a long period of low benchmark rates had created. It sold a 10-year bond, a rare high-yield security of that maturity out of Asia. The offering achieved the lowest coupon in 10 years for a company rated below investment grade.

That bond, due in 2023, has one of the highest duration risks among high-yield issues in Asia. What that means is that the price of the bond swings a lot more in response to changes in interest rates than almost any other sub-investment grade bond in the region.

The reason for this is because duration risk is determined by a bond's tenor and yield. The longer before the bond is redeemed and the lower the yield, the more the security's price will change as a result of benchmark rate shifts.

Country Garden's earlier 2023 bonds had a modified duration of 6.95 years when they were sold, which suggests the bond price would drop 6.95% for every 100bp increase in benchmark rates.

When Country Garden issued its 10-year bonds last January, the yield on the 10-year US Treasury was hovering around 1.9%.

After the US Federal Reserve minutes on May 22 indicated the Fed would taper its monthly bond purchases, the benchmark rate moved up and touched a high of 3% in the first week of September. It has retreated since, after a lackluster jobs report in the United States and the announcement that the Fed was maintaining monetary stimulus increased demand for Treasuries.

Country Garden's bonds reacted to these benchmark swings. Their price in secondary trading went from a high of 110.00 on May 10 to as low as 86.00 by late June. In the same period, the yield on the 10-year Treasury moved some 80bp.

Meanwhile, the price of another outstanding Country Garden bond, this one maturing in 2017 with an 11.25% coupon, moved from 114.00 to 111.00 in the same period. The much higher coupon and shorter maturity of this bond meant the duration was far shorter - in fact, at the current 110.00 market price, the 2017 bonds have a modified duration of about 0.5-year.

LESSON NOT LEARNED

The wild swings seen on Country Garden's 10-year bonds and the certainty that the Fed will soon start withdrawing monetary stimulus - even though it delayed that move in its last policy meeting - would suggest that investors would stay away from new bonds with high durations, especially bonds issued by Country Garden.

But the new US$750m 2021 deal, which priced this week with a 7.5% coupon and a high 5.7-year modified duration, still attracted US$3.1bn in orders.

"It's very encouraging to see some demand returning for duration," said a Singapore-based trader.

A banker close to the Bangkok Bank deal suggested it made sense for clients to be adding duration risk. "Some of our analysts are suggesting the yield on the 10-year US Treasury could be as low as 2.4% by year-end," he said.

Given that prices of bonds with long durations also rise more when benchmark rates drop, if the banker's predictions are right, buyers of the new Country Garden 2021s stand to win, as do buyers of the 2023s of Bangkok Bank and the 2043s of BHP Billiton.

However, one portfolio manager noted: "[Duration risk appetite] is not back as much as people are making it to be."

Indeed, even the banker admitted it may make sense for investors to add duration, but only for the next few months.

"This is a dangerous game to play, as soon as tapering talk returns these bonds will tank," said a credit analyst in Singapore.

For now, it seems investors are willing to take the risk.