Asia’s equity-linked market has never been a high-profile asset class, with investment concentrated among a handful of convertible bond funds. Investors had been paying even less attention in recent years as issue and redemption volume shrank.
Yet anyone who has invested in the asset class since 2015 will find themselves firmly in the black. For the most part, that reflects the outperformance of Asia’s stock markets against those elsewhere in the world.
What’s more, if the stock market maintains its strength, the equity-linked market could actually emerge as a particularly attractive asset class for investors, serving as a derisking and hedging tool against the soaring market.
Naturally, for issuers, it is a more attractive funding option than the straight debt market, which will become an increasingly costly alternative as the United States gradually raises its benchmark rates.
And contrary to a few years back, the investor base has been much broader with participation from equity and credit investors, private banks, as well as Chinese corporates with abundant capital. That means demand is no longer coming from the specific group of convertible bond investors that banks typically pitch to.
Equity-linked deal advisors have clearly spotted that trend. That’s why the Asia ex-Japan equity-linked market has undergone a series of changes, reflecting efforts to introduce new elements to the asset class to reverse its decline.
One of the characteristics of recent equity-linked deals is that they offer more choices of currency for investors.
For years, US dollar has been the definite currency for Asia ex-Japan convertible and exchangeable bonds. But as the world’s biggest economy started raising its benchmark interest rate in late 2015, US-denominated bonds are no longer as attractive as they were because investors can invest in higher-yielding products as the rate goes up.
Issuers soon realised the need to offer non-US dollar deals. Naturally, Chinese companies such as Kunlun Energy and China Railway Construction Corp (CRRC) have turned to renminbi-denominated bonds.
But some investors had expressed concern about Rmb-denominated deals because they will lose against the currency’s depreciation. The Chinese currency depreciated about 7% against the dollar last year.
From the issuer’s perspective, it is also not sensible to raise offshore Renminbi because it will incur extra costs for repatriating the funds back onshore.
Shanghai-listed China Yangtze Power was one of the innovative issuers last year by issuing a dual- tranche exchangeable bond into China Construction Bank’s H-shares, which included a $300 million US dollar-denominated and a €200 million ($235 million) euro tranche. There were no outstanding euro-denominated bonds in the market at that time.
That was proven extremely popular among investors, prompting fellow Chinese duo Zhejiang Expressway and 3SBio to follow suit by issuing €365 million and €300 million worth of convertible bonds respectively.
Yangtze Power’s deal was cleverly structured with different exchange premiums between the US and euro tranche.
Technically, picking the euro tranche allowed investors the option of enjoying a higher yield against the benchmark rate, while those choosing the US dollar tranche enjoyed lower exchange premiums and thus, a better chance of exchanging the bonds into shares.
In June last year, Indian drug maker Glenmark Pharmaceuticals printed a US-dollar convertible bond using a forward-pricing mechanism, which allows it to fix the conversion price 18 months later. This was another notable innovation in the equity-linked space and a structure that could be copied by other fast-growing companies.
By adopting such a pricing mechanism, the issuer can retain the equity upside for a certain period – a good option for companies that are in their high-growth phase of development.
The 360-day maturity means the issuer can raise short-term capital at low cost, while bondholders can look to potentially benefit from a near-term spike of the stock.
Equity-linked experts admit the asset class is not as robust as it was few years ago, when multibillion-dollar state companies and small private firms all tapped the market for funding.
But with the US rate hike gathering pace, convertible bonds and exchangeable bonds could become more attractive as a hybrid investment between equity and debt.
It is an asset class worth paying attention in the near term.