The Asian convertible bond market has come of age. Convertibles are now regarded as a separate asset class and as a vital part of the corporate treasurer's toolkit when it comes to financing. From an investment perspective, returns from convertible outright and hedge funds have been strong over a number of years.
After 1997 the active Asian convertible market consisted of some Japanese names and small Taiwanese high tech companies. The situation in 2004 is very different - Japan is back with large issues such as Softbank, Sony and Japan Airlines. The Taiwanese market has diversified and is booming with much larger technology issues and numerous financial holding companies issuing more than US$200 million deals such as Chinatrust, Fubon and Mega.
In 2003 we saw the birth of the Chinese domestic convertible bond market, and with short-selling regulatory changes expected in Taiwan and Korea, the markets there are expected to mature further with the entrance of hedge funds. Recent changes in Indian regulations have led to new convertible issuance including ACC and Indian Hotels.
Benefits of Convertibles
Regionally issuance is high and demand is strong. For the corporates, convertibles offer an ideal solution for raising capital as they are cheaper from a cash flow perspective than straight bonds (many pay zero coupon), and as conversion into shares can only occur at a significant premium to today's price, shareholders are less concerned about dilution. Convertibles can also be used to unwind cross-shareholding via exchangeable bonds whereby the bond issued by "Company A" converts into the shares of "Company B" ("Company A" usually already holds the shares of "Company B" and thus is able to unwind at a premium).
For investors, convertibles offer the security of a bond with the upside of equity, and, given the increase in issue size and number of investors, the bonds are much more liquid than a few years ago. Regionally in Asia we have also seen an increase in the number of hedge funds that are trading convertibles, typically buying the bond and selling the stock short where possible, which helps provide liquidity.
Like ordinary bonds, convertibles are sensitive to interest rates and credit movements but they also respond to share prices, equity volatility and possibly foreign exchange movements (many are US$ denominated bonds that convert into local currency shares). This means that sophisticated systems and accurate market data are essential for issuing, trading and understanding the associated risks. Over the last year we have seen a number of regional Asian banks and funds investing in this infrastructure in order to provide better service to their clients and enhance risk management.
Convertibles Set to Stay
Globally, 2003 was the second best year on record (after 2001) in terms of volume and convertible bond issuance, with over US$150 billion worth issued (more than half of which was from the US). There were over 115 issues from Asia Pacific totalling more than US$20 billion and the market is predicted to grow considerably in 2004. At the end of Q1 2004 there were already more than 50 issues from the region. There is no doubt that the convertible bond is here to stay and given the potential it looks like 2004 may be the year of the Asian convertible bond.