Fixed Income: An exciting decade for local bonds and sukuk

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on December 30, 2019 - January 05, 2020.
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The last decade saw tremendous growth in the local bond and sukuk market. The market grew from RM483 billion in January 2010 to RM1.3 trillion in November 2019, according to the Bond Pricing Agency Malaysia Sdn Bhd (BPAM).

Exponential growth was also seen in the number of bonds and the quality of the bond market. According to RAM Holdings Bhd, there were only two defaults in bonds and sukuk from 2010 to the first half of 2019.

Despite the commendable performance, the asset class has seen its fair share of volatility in the past decade. Two years ago, global bond yields rose because the US Federal Reserve began tightening its balance sheet. Bank Negara Malaysia increased interest rates in January 2018 as well, pushing bond yields upwards.

Things took a turn this year when the global economy showed signs of slowing down due to geopolitical tensions. The Fed lowered interest rates for the first time since 2008 and bond yields plunged, with about a quarter of the global bond market offering negative interest rates by August. Bank Negara lowered interest rates in May, sending the benchmark yield curve down.

The rising influence of geopolitical risk is the most significant event in the bond and sukuk market over the past decade, according to Hanifah Hashim, executive director and head of Malaysian fixed income and sukuk at Franklin Templeton GSC Asset Management Sdn Bhd.

“In 2016, the unexpected result of the Brexit referendum and the US presidential election impacted the bond market greatly, causing a spike in yields. On the home front, the unexpected change of government in 2018 was another political event that affected the bond market. Going forward, we expect political risk to continue creating volatility in the market,” she says.

However, the attractiveness of the asset class has not faded among investors. Bonds and sukuk provide investors with protection in uncertain times.

“The most important feature of bonds is their ability to earn a fixed rate of return throughout their tenure, regardless of whether rates go up or down. Thus, investors are able to enjoy more certainty on the total returns bonds can generate over a long-term horizon, which is crucial for long-term financial planning,” says Datuk Lee Kok Kwan, board member of the Bond and Sukuk Information Platform Sdn Bhd (BIX).

“As the returns are fixed, if the markets perform well, there is no upside beyond the locked-in fixed rate. Conversely, investors do not suffer the downside of collapsing prices if markets are performing poorly, provided that the issuer does not default.”

The returns of bonds and sukuk in Malaysia over the past decade have been superior to their alternative of fixed deposits. The Thomson Reuters (TR) BPAM All Bond Index was up 8.1% for the year to November while the TR BPAM All Sukuk Index was up 8.33%.

“Based on our calculation of the monthly returns of the TR BPAM All Sukuk Index from January 2010 to November 2019, the 10-year cumulative return was 59.53% or an annualised return of 5.99% per annum. Compare this with the one-year average tenure of fixed deposits reinvested yearly over the last decade, where the cumulative return was 36.32% or annualised at 3.66% per year,” says Hanifah.

Consequently, the demand for bonds and sukuk continues to outstrip supply, Lee observes. Institutional investors like the asset class for its relative safety.

“Take up is not a problem. That is why issuers do not worry about responding to retail investors’ demands. Purely serving the demands of the institutional investor base is more than enough,” he says.


Getting retail investors

into bonds and sukuk

This puts the spotlight on another major change in the last decade — the opening up of the local bond and sukuk market to more retail investors.

Previously, retail investors could not access this asset class directly. Banks sold bonds to institutional investors or high-net-worth individuals (HNWIs) for at least RM250,000. The high amount limited the involvement of retail investors.

“Previously, retail investors would have to invest [in fixed income] through bond funds, where they cannot be guaranteed of the yield and there was no certainty of cash flow. They probably had a rough idea of what bonds they were invested in, but that depended on the fund managers. Now, retail investors have the power to invest in the bonds they want,” says FSM Malaysia general manager Wong Weiyi.

FSM Malaysia, owned by iFAST Capital Sdn Bhd, is an online investment platform that sells financial products such as unit trusts and bonds. It launched its Bond Express platform to sell fractional shares of bonds to investors in 2017.

The Securities Commission Malaysia (SC) took steps to allow retail investors to have direct access to bonds and sukuk in 2012. In the introductory phase, retail investors could only access bonds and sukuk issued or guaranteed by the government.

In 2013, Bursa Malaysia launched the first retail exchange-traded bonds and sukuk (ETBS) on the Main Market. This enabled investors to buy or sell bonds on the bourse with a minimum of RM1,000. But the ETBS was not exactly successful in attracting retail investors. The yields were not attractive, liquidity was an issue and there were few transactions, according to reports.

The next phase of the retail bond and sukuk framework came in 2018. The SC introduced a new seasoning framework to offer retail investors access to existing corporate bonds and sukuk that were being traded by sophisticated investors in the over-the-counter market. These instruments must have been in the market for at least 12 months and have a minimum credit rating of A, among other requirements.

Currently, the only eligible distributor of seasoned bonds is iFAST Capital, which purchases bonds and sukuk and cuts them up into smaller lots to be sold to investors. Bond Express only sold fractional shares of bonds to HNWIs before 2017 for as low as RM10,000. With the seasoning framework, retail investors are able buy bonds and sukuk for as low as RM1,000 on the platform.

According to Wong, there were more than 850 retail bond transactions worth RM10 million and 650 wholesale bond transactions worth RM39 million on the platform from April to October this year.

The local bond and sukuk market has traditionally been dominated by institutional investors and financial market players. But in recent years, there has been an influx of HNWIs increasing their direct holdings of bonds, says Hanifah. “Although the amount invested by HNWIs in direct bonds is not readily available, we can see a clear increase in odd lots being traded and reported in the market.”


Levelling the playing field

The lack of price transparency and information were also identified as hurdles for retail investors to access the market. That is why the SC launched BIX, a portal that allows users to research the bond and sukuk universe, in 2017.

“Retail investors are at a disadvantage as they do not have credit research and analytics teams that the large institutional investors have. Retail investors also do not have execution and trading capabilities. That is why BIX is important in levelling the playing field. It is free and structured as a public utility,” says Lee.

BIX gives retail investors the ability to search the bond and sukuk universe by yield, credit rating and residual tenure, among other criteria. It also gives them the ability to conduct price discovery by referencing the prices of comparable bonds, including odd lots.

“If an investor wants to figure out if a bond is fairly priced or gauge what is fair pricing, he can go through the traded prices of the bond or sukuk in question, as well as the traded prices of comparable bonds of similar credit rating and tenure. BIX has the traded prices of each and every bond and sukuk since issuance, including the prices of old lots, which are usually retail private banking customer trades,” says Lee.

According to him, most of its users are currently institutional investors and private banking investors. Previously, they had to rely on analysts to do time-consuming research. But now, BIX brings all the information together on one portal with a sophisticated search engine. “Now, we have to help retail investors understand how to use it,” he adds.

Lee believes that an electronic trading platform for bonds will help to elevate the market.

Currently, there is still a limited number of bonds and sukuk available to retail investors at a low price. Wong observes that most of those on the Bond Express tend to buy and hold bonds, but few sell them. This results in a liquidity problem.

To improve the situation, retail investors should be allowed to invest in high-yield or unrated bonds, he says. “The yields for investment-grade bonds are in the 4% range. But unrated bonds have yields of 6% to 7%. If you are concerned about risk exposure, we can always set a cap. I think if yields are attractive, investors will be more excited to learn about bonds. If investors can go into peer-to-peer financing, equity crowdfunding and stocks, high-yield bonds should be at an acceptable level of risk.”

Wong suggests that the SC establish a recognised market operator to set up a bond exchange. “Now, as a dealer, we buy bonds and sell these to individual clients. But with an exchange, the clients can sell to each other and we do not have to hold all the bonds,” he says. This can facilitate price transparency and encourage liquidity in the market.

Advances in sukuk
A significant milestone for the local bond and sukuk market over the past decade came in 2014, when the Securities Commission Malaysia launched the Sustainable and Responsible Investment (SRI) Sukuk Framework. The first issue under this framework was the Ihsan Sukuk of Khazanah in 2015.

“This was the first SRI sukuk issuance globally and it was significant because it led to a steady increase in further issuances within the SRI framework, especially from the solar power industry. The addition of this new sector created diversification for the local bond and sukuk universe,” says Hanifah Hashim, head of Malaysian fixed income and sukuk at Franklin Templeton GSC Asset Management Sdn Bhd.

Another milestone was passed in 2017, with the issuance of the world’s first green sukuk by Tadau Energy. This was followed by other issuances that were in line with environmental, social and governance (ESG) principles. Earlier this year, the Bond Pricing Agency Malaysia (BPAM) launched the BPAM ESG Bond Index Series to track all ESG-related bonds and sukuk issued.

“As at end-November, the index consisted of 154 bonds, with a market capitalisation of RM5.285 million. Analysing the index, the year-to-date return for the BPAM ESG All Index was 9.2% compared with the TR BPAM All Index’s 8.1%,” says Hanifah.

These advances reflect Malaysia’s role as a major supplier of sukuk globally. This segment of the fixed income market is expected to grow, especially as it is outperforming regular bonds.

“Over the past decade, the TR BPAM All Sukuk Index generated an annualised return of 5.99% compared with the TR BPAM All Bond Index’s 5.14%. We foresee continued demand for sukuk from onshore players to persist as sukuk becomes a mainstream investment vehicle locally,” says Hanifah.


Outlook for next year
Volatility is expected to continue in the local bond market next year. The US-China trade dispute and subsequent slowing global growth will continue to impact markets, says Hanifah Hashim, head of Malaysian fixed income and sukuk at Franklin Templeton GSC Asset Management Sdn Bhd.

A silver lining is if Bank Negara Malaysia cuts the overnight policy rate in view of slowing growth, which will benefit the bond market. On the flip side, an upcoming risk to the asset class is if FTSE Russell removes Malaysian government securities from its index in March next year.

“The exclusion may result in capital outflow and will have a negative impact on the bond market. Nevertheless, investors should always view investments in bonds as long term. Based on historical performance, bonds may provide returns that exceed those of other asset classes when the economy is not doing well,” she says.

While the returns in 2019 are unlikely to be repeated, global rates are expected to stay low for longer. Hanifah expects local fixed income to continue providing reasonable returns in the next 12 to 24 months.

“If we look at Malaysian bond yields, they have exhibited a very stable risk profile of over 5% index return in the past decade due to the continued demand for bonds and sukuk, plus the ample liquidity in the Malaysian economy. We are optimistic that the local bond market will continue to provide decent returns in 2020 and beyond,” she says.

FSM Malaysia general manager Wong Weiyi observes that equities still have room for growth next year. He suggests that investors allocate 55% of their portfolios to equities and the rest to bonds.

“We like equities, at least for next year, because we think Asian equities are cheap. All the negative news has been priced into the market, whether it is the US-China trade war or lack of earnings growth in Asian companies. [Valuations of] US equities still remain stretched,” says Wong.

“Malaysian bonds are attractive as the yields of other bonds are lower. We advise investors to have 70% local bonds, with a mix of government and corporate paper.”