Will volatility boost fixed term fund appeal?

Asset Class in Focus

BNPP AM has raised $170m from private banks in the region for a fixed maturity plan, according to Karan Talwar, Hong Kong-based investment specialist for emerging market fixed income.

Karan Talwar, BNP Paribas Asset Management

Fixed maturity plans or fixed term funds are closed-ended funds with defined parameters, including the tenure of the fund and the payout rate.

BNP Paribas Asset Management launched in November a four-year fixed maturity plan that offers investors an annual rate of three-month Libor plus 180bps net of fees, to paid on a quarterly basis.

According to Talwar, the firm was able to raise $170m, mostly from private banks in Hong Kong and Singapore, in three weeks.

Talwar believes that fixed maturity products have become more popular due to the return of market volatility after nearly ten years of relative calm.

“You had, for example, for the same credit quality, Chinese high yield having higher spreads than Argentinian or Turkish high yield bonds. That is how much negativity was being priced around the [US-China] trade war,” he said.

Because of that risk, other asset managers have also started to be more aggressive in their fixed maturity bond offerings, he said.

Fixed maturity products became more popular in some Asian countries last year. For Taiwan-domiciled funds, the product category had the highest net inflows of NT$92bn ($2.99bn) last year, according to data from Morningstar Direct.

In Thailand, it was the second most popular product category, attracting THB 95.9bn ($3.06bn) in net inflows last year.

Fixed vs floating

Talwar noted that his firm’s product has a floating rate (in this case, Libor) payout structure, which is different from the fixed rate structure which is often required by institutional investors.

“This is done by having an interest rate swap at the overall fund level in order convert a fixed rate payout structure to a floating rate one,” he explained.

Talwar believes that a floating rate structure is appealing to private bank clients as many of them usually use leverage to access these strategies.

“If they are taking leverage, their borrowing costs are uncertain. With interest rates rising, that means their borrowing costs could rise. So in this kind of structure, clients are getting the returns on Libor, [which is linked to rising interest rates], plus 180bps.

“So effectively, they are able to negate or hedge the volatility associated with Libor moving around because their borrowing costs and fund returns will be more closely linked.”

Talwar added that other fund managers have also started to offer floating rate structures to private banks in the region.

BNPP AM hopes to launch another four-year fixed maturity plan to private banks next month, also providing an annual rate of three-month Libor + 180bps, according to Talwar.

Managing risks

Managers should have defined investment parameters before launching fixed maturity plans, according to Talwar.

“The idea is not to trade excessively. We should have a very clear model of the cashflow. So as long as there is no default in any of the bond holdings, we can give investors clarity — that if you own this product for x number of years, your return will be x%,” Talwar said.

For the firm’s four-year fixed maturity product, the fund’s average credit quality should be investment grade. While it can invest in high yield bonds, it cannot invest in bonds rated CCC or below. It also does not invest in unrated bonds.

Only 10% of assets can go to a single country and 25% to a single sector, and positions are taken only in US dollar-denominated bonds, according to Talwar.

Despite the home bias that is prevalent among Asian investors, the fund invests globally.

“Historically speaking, we’ve seen that there has been a strong bias for Asian investors to remain in Asian fixed income assets. This is partly justified as historical returns in Asia have been extremely strong and default rates have been very low,” Talwar said.

However, since the start of 2017, as China began its deleveraging process, default rates in onshore and offshore bonds have started to pick up, according to Talwar.

He added that last year, the default rate for US dollar-denominated debt in Asia was at 2.5%, which is higher than the emerging market average of 1.5%.

“Asia actually has become more risky.”

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