Carley's way

Jason Carley, head of fixed income research at Merrill, talks about some of the calls that have upset investment banking.

Have you seen a trend this year of fixed income research moving down the credit spectrum?

It's been an interesting year in that regard, because high yield in Asia hasn't done terribly well. Realistically, our goal in providing high yield recommendations at this point in the cycle has been to help investors avoid problems, rather than suggesting aggressively that investors allocate into high yield names. There have been some high yield bonds that have done well through the year and we continue to like them. But realistically, when you look at some of the default rates in Asian high over the past two years, they are horrific.

Consequently, the focus from our end has been on pointing out the credit stories with positive characteristics while trying to help investors avoid getting involved in Hynix-type situations, or other potential "landmines"

So what has been the trend this year? How has lower interest rates affected your area?

Certainly bonds have been back in play. Issuers, given the weak equity markets, have been looking more at debt financing. That being said, the overall volume of new deals has been somewhat underwhelming. It has been better than 2000, but its certainly not close to the glory days of the pre-crisis Asian bond market. The bank market here is very important and the local currency market is becoming more relevant so current market volumes are probably realistic.

In many ways, from a credit research standpoint, you have to be much clearer than in the past and have more insight to get international investors interested in the product. Your clients are not falling over themselves to buy Asian bonds unless there is a compelling investment story. It is our job to convey that story and get them interested when that is appropriate.

What are the interesting trading ideas you've had this year?

Broadly, from a strategic standpoint, some houses have been suggesting a balanced portfolio - high grade and high yield - whereas we've been much more conservative than that, for the last 12 months. We've told investors to focus on high grade Asia, and honestly that's worked very well. High grade Asia has outperformed high yield Asia for the last two years. Investors just haven't been paid for taking high yield risk in Asia.

From a trading standpoint, across both bonds and convertible bonds, we've had other occasions such as the Korean bank sub-debt where we've had strong buy calls and they've performed very well. On the other side in names like PLDT and BayanTel we had some against-consensus calls. PLDT, in the second half of this year has been the worst performing bond in Asia. It is a good company from an operational standpoint, but clearly they have liability management problems. And BayanTel defaulted. Our call on BayanTel for example came as one house in particular had a buy recommendation virtually all the way down from par. Hopefully we managed to save clients some money on that bond even though selling at 50 cents on the dollar must have been very hard for them to do.

Do you spend much time talking to hedge funds?

We do talk to hedge funds, both from a bond standpoint, but also from a convertibles standpoint. They have been very active on convertibles. Additionally, there has been a lot of activity in the credit derivatives market that has really linked the bond and the convertible bond markets and been the hedging vehicle between the two. Hedge fund clients are often very interested in these types of arbitrage opportunities and many of them have arisen over the past year.

How many real investors are there in Asian credits? Are there 15-20 who would move the market and others would follow?

That is probably fair. Any list of investors can be as long as you want it to be. However, while a lot of investors globally have some Asian bond exposure, it would tend to be 20-30 real-money investors that are active participants in Asian primary and secondary markets.

Has fixed income research improved in Asia since the financial crisis?

A better perspective could probably be given by someone who was actually here and covering the market during that time, but based on what I've seen since arriving in Asia, the market now seems more competitive. There's a lot more research and it is more mature than it appears to have been in the past. The market now is predominantly high grade. There are a lot of very high quality issuers and the focus of credit research has adapted to that. So from what I can tell, it has moved a long way, and there are many more people doing it.

With Merrills being a very active player in lead managing bonds, how does the research product keep its integrity?

I guess it comes down to individual integrity as well as how the structure is set up. At Merrill Lynch - and I know everyone says this but in our case I can say that the structure supports research integrity very well - very strong Chinese walls exist. First of all, Research has its own reporting line to the top of the firm and doesn't report to Investment Banking or Trading, Investment banking has nothing to do with research decisions, or who we decide to cover. They can't change research nor do they approve it. From a personal standpoint, I can say that this system really works here.

Can you name two calls that would have upset the investment banking side?

We came out fairly negative on PLDT's debt position earlier this year. We also cautioned investors about the structure of PCCW's attempted bond issue in July. Both of those companies are clients of the firm (as are most issuers in Asia), but in neither case did we get any feedback on the research from anyone on the banking side at Merrill Lynch and that is really as it should be. In my view, investment bankers and originators here recognize that the value of research is realised over the long term rather than the short term. Compromising research to win a mandate or sell a bond may actually lose you more business than it gets you.

When you have a strong idea, what is the most effective way to communicate it?

From a compliance standpoint, our focus is on getting the idea out to the entire client base. All of our ideas need to go on paper first. But realistically, personal contact is the best way of disseminating an idea, especially when clients receive a lot of research. And once you've published a piece of research, it is much easier to bring people's attention to it via a personalized email or a phone call.

Is it like on the equity side? Do fund managers directly reward good research with more orders?

It is far less formalized than on the equity side. Some houses have implemented some type of voting systems internally. In Asia, that is quite rare. But let's not be nanve, the reason investment banks do research is to get more business from clients. We hope that if clients find our research of value, they pay the firm for it in some way and in general I think that occurs.

So you were in Australia before?

Yes. I was doing research on Australian credits, and have been with Merrill now for just over three years. I have been covering credit on the sell-side for about eight years.

What are clients' concerns about Asian credit research?

One comment I have heard is that they are besieged by credit ratio analysis, which is clearly the first thing you focus on when you are doing the financial analysis of a company but it isn't the end in itself. A number of clients have pointed out that what they want is an opinion. In the end all credit research is a value judgement. You can do as many spreadsheets as you like, but that doesn't really give you an answer. Plenty of companies have great ratios on paper, but end-up defaulting anyway. Realistically, the interaction between a company's business, management, and financials is what clients want. They also want market analysis. There's little point coming up with a great call on a bond that is impossible to buy. And you may have spent weeks coming up with some great strategy - but if no one can execute it, it's of no use except as an academic exercise.

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