KEY POINTS:

Performance to Date

Let us take a look at the performance of the Malaysian Bond market (as of 30 September 2011).

CHART 1: MGS, PDS and KLCI YTD Performances

The demand for higher yield amidst the low-yielding environment in developed countries has boosted the performance of Malaysian Government Securities (MGS) and the Malaysian corporate bonds (PDS). Both the indices have recorded a return of 3.52% and 5.61% year-to-date respectively as of 30 September 2011 (as shown in Chart 1). The escalating risk aversion of investors also caused a sell-down in global equities which caused the FBM KLCI to mark a loss of 8.68% year-to-date.

September: Yields Spiked; RM Weakened Against USD

CHART 2: MGS Yield

However, as the leaders of the Eurozone acted slowly in finding a solution to the Eurozone debt crisis, weak investor sentiment was magnified and dragged on into September. Investors’ risk aversion increased and they started to take profit from government securities of riskier countries such as Malaysia and sought safety in safer government bonds like the US Treasury (US 10-year government bond yield reached an all-time low of 1.8576% on 21 September).

This caused MGS yields to spike across the board since mid September (as shown in Chart 2). The inverse relationship between yield and bond price meant that the performance of MGS suffered as well (you may refer to “Interpreting Yields For Bond Funds” to understand the relationship between yield and bond price).

Also, this caused the RM to weaken against the USD by 7.1% during September. The year-to-date appreciation of the RM was wiped off (as shown in Chart 3). 

CHART 3: RM Per USD

MGS Yield at an Unattractive Level

CHART 4: 10 Years MGS Yield

Chart 4 shows the yield of 10-year MGS from 3 January 2001 to 30 September 2011.

We can see that the yield is currently around -1 standard deviation from its long-term average (in blue box) which we consider as unattractive when compared to the yield during the 2008 financial crisis and also in 2009 and the beginning of 2010 (highlighted in orange).

Although the MGS yield has spiked after the recent sell down, we believe that it will remain at this level in the longer-term as Bank Negara Malaysia (BNM) has slowed down its policy tightening. This is in view that the inflation rate has eased in August and the slower global economic growth may have an impact on the Malaysian economy.

CHART 5: Inflation Rate and Benchmark Interest Rate

BNM maintained the benchmark Overnight Policy Rate (OPR) at 3% in the September 2011 Monetary Policy Committee meeting. The year-on-year inflation rate eased to 3.3% in August which is near its 6-year average (refer to Chart 5).

Is Private Debt Securities (PDS) Attractive?

As the MGS yield remains unattractive, investors may wonder about the prospect of Malaysian corporate bonds (PDS).  Let’s take a look at the yield spread between the PDS and the MGS.

CHART 6: Yield Spread

Chart 5 shows the yield spread between the 10-year AA-rated PDS and the 10-year MGS for the period from 15 January 2002 to 30 September 2011. Since the 2008 financial crisis, the yield spread bounded between its long-term average and its +1 standard deviation.

The recent yield spike in MGS has caused the yield spread to fall (in blue box). However, the yield spread is still higher compared to the pre-crisis levels (highlighted in orange).

As such, we are in view that PDS which yielding 5.701% as at 30 September 2011 remains attractive.

Should Investors Worry About Recent Sell-down?

To find out whether the ongoing Eurozone debt crisis will have a significant adverse impact on the Malaysian bond market, we looked at its performance during the 2008 financial crisis.

Chart 7: MGS and PDS Performance During 2008 Financial Crisis To 30 September 2011

Chart 7 shows the performance of MGS and PDS during the 2008 financial crisis from 2 January 2008 to 31 December 2009 (highlighted in orange) until 30 September 2011. As shown in the chart, there were two periods where the indices dropped drastically (in blue boxes) during the crisis. We also observed that during these two periods the PDS was more resilient than the MGS even though the MGS is perceived to be of lower risk than the PDS.

Having said so, the indices each gained 9.0% and 9.7% respectively during the crisis period and 18.4% and 23.6% respectively from 2 January 2008 till 30 September 2011 (in RM terms). Therefore, we expect the impact to the PDS will not be that substantial if the current situation worsens.

Furthermore, we expect Malaysian economic growth to remain stable, driven by the Economic Transformation Programme (ETP). IMF in its September World Economic Outlook report forecasts Malaysia economy to grow 5.2% this year (in line with Malaysia government’s target of 5% - 6%) led by robust investment, which may offset the slowdown in exports.

Implications for Investors

The weakening economic data in the US and Eurozone and the slow action from the European leaders to resolve their debt crisis have forced us to revised down our US and Eurozone GDP forecasts. However, we still maintain an “overweight” call on equity as the valuations for most equity markets still remain compelling even after our downward revision of earnings estimates.

In addition, we continue to advise investors to invest in fixed income funds as a means of diversification through a different asset class.  Our choice for fixed income funds would be Malaysia Bond funds owing to its resilience during the 2008 financial crisis and also to the lack of translation losses caused by the exchange rate movements.

When choosing Malaysia Bond funds, investors should choose bond funds that have a high allocation in higher-yielding PDS.

Recommended Malaysia Bond Funds:

AmDynamic Bond Fund
AmBond Fund
RHB Islamic Bond Fund

Related articles:

AmDynamic Bond - The Star Of Malaysia Bond Fund
Double-dip Recession Lessons from History
Key Changes To Investment Outlook
Looking Past The Current Turmoil - Upgrading 12 Markets; Downgrading Europe
Europe - What happens If There's NO Growth
How Value Investing Works In Unit Trusts?

The Research Team is part of iFAST Capital Sdn Bhd

This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any fund. No investment decision should be taken without first viewing a fund's prospectus and if necessary, consulting with financial or other professional advisers. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Past performance and any forecast is not necessarily indicative of the future or likely performance of the fund. The value of units and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.