Bonds Have more Fun
Philippine bonds have become a favorite of many fixed income investors
By Warner Manning

The Philippine equity and fixed income markets are currently experiencing strong performance. The PHISIX is up 28% from end 2002. Meanwhile, Peso and US dollar bond yields of the Republic to date are significantly lower. The five-year FXTN yield is down from 12.567% to 11.575%, while the ROP Global Bonds due 2009 which were priced just last year at 8.375% now trade at 6.5% – 6.7% levels. In both cases, the drop in yields on Philippine bonds has resulted in significant capital gains for the bondholder.

When dealing with investments, a prime consideration is “endurance” and “consistency” of returns.

The past three to four years saw major challenges for the Philippine economy. On the domestic front, we have experienced political uncertainties, slower than forecasted GDP growth, and an increasing fiscal deficit. There are indications, however, that this year will buck the trend of an increasing deficit as the government has made significant headway in its revenue collection efforts.

Externally, the key factors impacting the Philippine economy have been the slowdown in growth around the world, the terrorism-related geopolitical crisis, and a close-to-economic recession of our major trading partner, the United States.

Through all these, the bears in the global equity markets went on a rampage, losing billions of US dollars in shareholder value for investors. And only in the past six months have the equity markets begun forming a base upon which a bull run could ensue, hopefully.

Meanwhile, as the bears dominated the equities market, central banks around the world brought down global interest rates, setting the stage for a bull run in the bond market that continues to exist to date.

Why bonds are here to stay
In the past few years, Philippine bonds have become a favorite both among international and domestic fixed income investors due to their attractive yields. The Philippines, because of its credit rating and available supply in the secondary market, continues to issue medium- and long-term bonds at levels of eight percent and above in US dollars, providing one of the best returns available in the region. We expect this strong support for Philippine bonds to continue for the next few years, due to the following factors.

First, central banks around the world continue to cut interest rates. On 25 June, the U.S. Federal Open Market Committee cut the funds rate by 25 basis points to new historical low of 1.00%. This is the lowest the funds rate has gone in 45 years. The Fed has signified that it is willing to cut rates further when the Open Market Committee meets again on 13 August. It is in situations such as this that fixed income investors are able to make significant capital gains.

Second and related to my first point, the relatively high coupon rates obtained from Philippine credits provide investors with the necessary yield pick-up that makes investing in fixed income securities worthwhile.

Third, the continued lack of direction in the equities market, both onshore and in the major markets like the U.S., provide added incentive for bond investors to keep within the confines of the more certain fixed income market. There is now a greater perceived need by investors to diversify risk among equities and fixed income investments.

Fourth, the “Asian Affinity” exhibited by investors this side of the Pacific can also contribute to the continued success of Philippine bonds. As demonstrated by two global bond issues lead managed by HSBC for the country last year, over 55% of the bonds were subscribed by Asian-based investors.

Philippine Bonds Performance Review
Let us take a closer look at the performance of Philippine bonds since 1999.

Most of the time since the establishment of the HSBC Asian Dollar Bond Index in 1999 up to around January 2002, Philippine bonds have lagged behind other country-components of the index in terms of total returns.

From January to September 2002 however, Philippine bonds outperformed the average Asian asset class with a 12.4% return vis-à-vis the 12.1% return of the composite index. From September 2002 onwards, we have seen total returns from the Philippines almost approximating the index levels, suggesting a greater dependence by the National Government on offshore bond issuance as a source of financing and more importantly, capital gains as a result of lower interest rates.

Where spreads are concerned, Philippine bond spreads have been significantly tightened from their peak in October 2001. This, along with the continued downtrend in underlying interest benchmarks, provide for an environment ideal for issuing bonds.

Comparison to Stock Market
Meanwhile, if the performance of Philippine bonds are compared to the stock market, we will find that the fixed income alternative has fared much better as compared to investments in equities.

Over a three-and-a-half year period, we will find that an investment in equities (using the Philippine Composite Index as a gauge) would have resulted in a 39% loss, whereas investments in Philippine Dollar-denominated bonds (using the ADBI Philippine Index as a gauge) would yield a return of 57% to date.

Even the Fixed Rate Treasury Notes would have been better investments vis-à-vis stocks. From end-2000, an investment in domestic bonds would have resulted in a return of 52% to date.

An investor who put his money in a basket of Asian stocks over the same period would not have fared any better. Using the Morgan Stanley (Far East ex-Japan) Index, the investor would still have lost over 38% of his initial funds since year-end of 1999.

Conclusion
In conclusion, allow me to summarise our views on the market.
Bond markets will continue to be supported by low interest rates, a deflationary environment and continued volatility in the stock market. Potential returns on Asian bonds will be significant due to the favourable supply and demand dynamics and the stable and improving credit fundamentals of the region.

Returns from Global bonds have surged by 22% in the last 12 months while the MSCI declined by three percent in the same period. In this existing environment, we expect bonds to constitute an integral part of investors’ portfolios.