Within fixed-income circles in Thailand, when people mention the word "kimchi" they’re not talking about their favourite dish or watering hole in Seoul. They’re talking about the big pool of Korean sovereign and central bank debt that Thai investors have dived into head-first over the past three-and-a-half years.
Kimchi mutual funds, which is the name coined for Thai-based mutual funds focusing on Korea, make up 30% of foreign holdings in Korean central bank and government bonds. According to Korea’s Financial Supervisory Service, the combined Thai holdings were worth W17 trillion ($14.5 billion) at the end of 2009. The figure quashed the $7.2 billion owned by US investors, which are the second largest holders of Korean debt.
The gate opened for Thai investors in 2007 when the Bank of Thailand relaxed foreign exchange regulations and made investments into foreign currency bonds more accessible. As liquidity was squeezed out of the US dollar markets, Thai investors, like other investors in the region, started to look elsewhere.
At that time, the Korean market looked like quite an attractive destination for Thai cash. Between 2007 and 2009 the Korean won basis widened considerably -- from 50bp to 600bp. Given the attractiveness of the market, Kimchi mutual fund managers targeted short-end government bonds and hedging to take advantage of dollar/won swap rates. In addition, Thai deposit rates were well below 1%, which prompted fund managers to search offshore for healthy returns.
“For a Thai retail investor, a capital-guaranteed Korean bond fund offering returns of around 2.5% to 3.5% in Thai baht terms looks very attractive,” said Danny Suwanaputri, senior rates strategist at Standard Chartered.
However, the trend seems to be slowing considerably as the Korean won basis has narrowed and market specialists plus the Bank of Thailand have taken on a more hawkish view of Thai rates. By the end of June this year, the total assets under management of Korea-focused Thai foreign investment funds into Korea had dropped to Bt450 billion ($14.4 billion). And, according to Standard Chartered, this figure is expected to drop further as key investors into Kimchi funds are planning to scale back the rollover of these assets under management well into the first quarter of next year.
“A number of these foreign investment funds do not plan to launch any new Korean funds and instead plan to channel their investments into other products, such as domestic money market [instruments] and corporate bonds,” explained Suwanaputri.
In July of this year, the Bank of Thailand hiked rates for the first time in 23 months to 1.5%. Coupled with further regulatory changes, the domestic bond markets currently stand as a far more attractive option for local fund managers. And, according to some specialists, given the tightening swap rates for the Korean won, fund managers may invest their cash in India and Taiwan instead of Korea.
The main trigger that could steer Kimchi managers back (en masse) towards Korean government and corporate bonds is if the Korea won basis widens. The Korean markets are traditionally volatile and therefore this could well happen again. For instance, further changes are expected to the foreign exchange regulatory environment in Korea, which could result in a renewed widening of rates.
However, with the expected reduction in the quarter-on-quarter rollover rate of Kimchi funds, specialists expect US dollar liquidity to return to Thailand, channelling fixed-income investments back into the domestic markets for a little while longer.
According to Bloomberg, the 5% Korean government bonds due in June 2020 tightened 3bp in yesterday’s trade.
