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Fixed Income Issue - Analysis of foreigners’ latest net selling of won-denominated bonds

February 22, 2016 12:00lFebruary 22, 2016 12:00
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Over the past two weeks, foreigners have net sold W3.3tn worth of wondenominated
bonds. Despite mounting concerns of capital outflows from the domestic bond market, we note that foreigners’ latest selling has centered around
1yr (and shorter) bonds. Moreover, given their sustained buying of mid- to longterm
bonds and in the KTB futures and swaps markets, we believe that foreign
investors remain upbeat towards won-denominated bonds. Expecting the BOK
to deliver two base rate cuts this year, we advise expanding the duration of bonds
upon yield hikes (to be triggered by capital flight concerns).

Foreigners’ latest net selling centers around short-term bonds
Over Feb 1~15, foreigners net sold W3.3tn worth of won-denominated bonds,
aggravating concerns of foreign capital outflows. Yet, we point out that the selling
centered around 1yr (and shorter) bonds, with soon-to-mature bonds—KTB ‘11-1’ (to mature in March) and MSB ‘1604-2’ (April)—together representing around W1.8tn of the net selling amount (W3.3tn). This indicates that certain global asset management firms (ie, Franklin Templeton Investments) with large exposure to short-term Korean bonds took a leading role in triggering foreigners’ latest net selling spree.

Selling pre-emptively and due to portfolio rebalancing
We attribute foreigners’ recent net selling actively to their increased desire: 1) to
rebalance their portfolios (to center around DM treasury bonds); and 2) to preemptively sell soon-to-mature bonds (ie, those slated to mature in March and April (to reinvest the proceeds in similar maturities)).

Recently, in line with the growing flight-to-safety trend, global capital has been
flowing out of EM bond funds and into DM bond funds. In particular, we point out
that Franklin Templeton Investments, a major investor in EM bond markets (including
Korea), has witnessed steady capital outflows from its funds since 2015. And, it is
worth mentioning that 28% of Templeton’s won-denominated bond holdings (total
bond holdings of W13tn (as of Dec 2015); held by six Templeton funds investing in
Korean bonds) were among the top-five Korean bonds in terms of foreign net selling
in 2016 (KTB ‘11-1’, MSB ‘1606-2’, MSB ‘1604-2’, KTB ‘13-7’, and KTB ‘05-5’).

Meanwhile, we believe that foreigners’ pre-emptive selling of soon-to-mature Korean
bonds (ie, those set to mature over March and April) also comprised a portion of the
recent foreign bond selling. According to our analysis, with a view to avoiding
concentration of rollover-related trading just prior to maturity, foreigners tend to sell
their holdings prior to this period, and later reinvest the proceeds in similar maturities.

We point out that out of the W3.3tn worth of won-denominated bonds net sold by
foreigners in February (as of Feb 15), W1.8tn worth of KTB ‘11-1’ (matures in
March) and MSB ‘1604-02’ (April) was sold (in total).

Expand duration upon bond yield rebounds
Believing that foreign investors’ current selling spree is being led by global asset
management firms, no more than W2tn~3tn worth of bonds should be additionally
offloaded over the short term. As foreigners continue to net buy domestic mid- and
long-term bonds and in the bond derivative markets, we believe that they remain
upbeat towards the domestic bond market. In addition, we expect the Bank of Korea
(BOK) to make two base rate cuts in 2016. Thus, we recommend expanding
duration upon bond yield rebounds (on capital flight fears).
peter.park@nhwm.com
*Source:NH Investment & Securities Co.