By MOHAMMED HADI, 230910

 

The yield seekers are going native.

 

Lured by high interest rates on offer in places like Thailand and India, relative to developed markets, as well as the prospect of foreign exchange gains, global investors have poured $19.3 billion into local-currency bond funds this year, according to EPFR Global—more than in the previous five combined.

 

The inflows are a boon to the development of local markets, adding liquidity and spurring trading that will make it easier for investors to buy or sell. For example, trading volume in Malaysia was up 47% by June from a year before, Asian Development Bank data show.

 

The demand might also bring new issuers to the market. The appetite for local currency debt means companies don’t have to take on foreign-exchange risk like they would by selling a bond denominated in dollars. And the demand is making borrowing cheaper, a possible inducement to companies that have been wary of tapping bond markets to finance growth.

 

There’s plenty of those in Asia: Only 7% of Asian corporate funding comes from bond issuance, compared with 18% in the U.S. and 16% in Europe, says Neeraj Seth, head of Asian credit at BlackRock.

 

But this could become too much of a good thing. Push bond yields down far enough, and they no longer reflect the risk inherent in owning the debt, says Ashish Agrawal, fixed income strategist at Credit Suisse.

 

He points to one popular destination to illustrate. In Indonesia, outsiders have been paying prices that locals won’t: Between January and mid-September, foreign ownership of government debt rose 52%, even as Indonesian banks, mutual funds and pension funds cut back. The outsiders take comfort in Indonesia’s growth and improving finances, but they’re also overlooking rising inflation and the potential for a hike in policy rates later this year.

 

The demand for Indonesian bonds is also distorting monetary policy by pushing short-term government bond yields below the central bank’s 6.5% benchmark. Yields on one-year Indonesian treasury bills are currently as low as 6.1%, although it’s easy to see why this is still appealing to foreign investors: One-year U.S. treasury bills yield 0.25%.

 

Central bankers have another reason to worry: What happens if the investors suddenly decide to leave? It’ll matter more to some than others. Foreign ownership in Thailand has nearly doubled since the end of June, Standard Chartered estimates, but outsiders still hold only about 6% of the total market. In the much smaller Indonesian market, outsiders own close to 28%.

 

If there is a sudden rush to the exits, though, it won’t just be central banks that have a problem.

 

Write to Mohammed Hadi at mohammed.hadi@dowjones.com

Source: Proshare