Friday, September 10, 2010

RMB bonds - are they worth it?

Bond issues denominated in RMB have been very popular. In fact bond issues are popular generally. There are no shortage of stories about investors pulling out of stocks to invest in bonds. I put some relatively small sums into a few RMB issues over the last two years and a slightly larger sum into HSBC's 6.8% due 2038. The latter has been a good investment and the former haven't done me any harm.

The latest "hot" offering is by BOCHK which is offering two tranches by way of public offer - Tranche A due in 2012 paying 2.65% and Tranche B due in 2013 paying 2.9%.

Should I buy these bonds?

Looking at the Tranche B issue, the annual yield is less than a lot of stocks pay (including the dividend on BOC's own shares). The only real case for buying on yield is that the bonds are of sufficiently short duration to be viewed as an alternative for cash. If I had meaningful amounts of RMB, I would be happy exchanging bank deposits paying zero for bonds paying 2.9%.

Since I don't have meaningful amounts of RMB sitting around, the comparison between RMB bank deposits and the RMB bonds is not valid for me. I have to compare the HKD cash that I would convert to RMB with other things I could put those HKD into.

If one accepts the often voiced opinion that the RMB is undervalued against the HKD (which is pegged to the USD) and arbitrarily assume that the RMB will appreciate by 20% over the three year life of the bonds then the total return is 2.9+2.9+2.9+20 = 28.7% less the FX conversion spread and bank charges on the receipt of each semi annual interest payment. There is no compounding of the interest received given that deposit rates are near enough to zero. This is is roughly 8.4% compound p.a. (depending on fees and spread) which is a very decent rate of return - if the FX appreciation actually happens (a point on which I am agnostic). As alternatives, one can find no shortage of shares listed in Hong Kong with higher yields and the potential for capital gains which may or may not be larger than the potential for appreciation of the RMB. There is no certainty that the RMB will appreciate against the HKD by 20% - or at all.

Of course, there is less downside risk investing in bonds than in equities. Safety favours the bonds.

Lastly, buying some more bonds would make my portfolio more diversified which would not be a bad thing.

In the end, it is unlikely that I will buy these bonds (at least not in any great quantity). If I can buy equities with better yields (which have the potential to grow) and which have the potential for greater appreciation, then I will take that over the relative safety of bonds and the more limited potential for currency appreciation.

Note: once I retire I will allocate a part of my investments to cash and short term interest bearing products. At that time the case for short dated bonds like this becomes stronger.

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