The catalyst for the sudden popularity was the decision by the Taiwan Insurance Bureau in November last year to include investments in so-called Formosa bonds (foreign currency issues listed on the Taipei exchange by non-domestic companies) into the calculation of insurance companies’ 65.25% foreign investments cap. The move had first been flagged in 2017, so insurers were prepared.
Insurers also found a loophole. They lobbied providers to launch Taiwan-listed ETFs mandated to buy foreign corporate bonds.
These types of ETFs, which side-stepped the foreign investment restrictions, are growing at a rate of 30% a month, according to Citi research, and are set to generate $40bn of cumulative inflows before the end of 2020.
So far this year, 22 ETFs investing in foreign bonds have already listed in Taiwan, according to the Taipei Exchange website. Issuers include Yuanta (the biggest ETF provider across asset classes), Cathay, Fubon and Fuh Hwa.
Selection of Taiwan foreign bond ETFs listed in 2019
|CTBC China Corporate 5+ Year USD IG Bond ETF|
|Capital ICE 15+ Year AAA-A US Healthcare Exchange Traded Fund|
|Yuanta US 10+ Investment Grade Utility Electric Power Bond ETF|
|Fubon FTSE Asian Broad Bond Index – China, Investment-Grade ETF|
|Fuh Hwa 8+ Year Financial Subordinate Bond ETF|
|Cathay Bloomberg Barclays 15+ Year Technology Bond Select ETF|
|KGI 15+ Year AAA-A US Corporate Bond ETF|
|Fuh Hwa US Treasury 20+ Year ETF|
Source: Taipei Exchange
Bloomberg reported in late January that Taiwan’s Financial Supervisory Commission had become concerned, and apparently asked major insurers to review the liquidity of their bond ETF holdings and assess their levels of investment concentration.
Bond exchange traded funds (ETFs) are still the poor cousins in the $5trn global ETF market, with assets under management worldwide of about $700bn, according to Goldman Sachs research. However, US Treasury bond ETFs, in particular, attracted inflows last year — $97bn according to Bloomberg data — as investors escaped volatile equity markets and sought a haven in high quality fixed income securities.
However, they suffer from structural problems caused by the illiquidity of most bond markets. Benchmark indices can rarely be fully replicated because of the difficulty of accessing all bond issue components, so its usually necessary to build optimized portfolios.
Moreover, dealers in bond ETFs can struggle to offload bond positions when there are fund redemptions, and therefore could be forced to hold a redeemed ETF as inventory.