Bonds looking up
Georges El-Hedery looks at why international investors are increasingly holding bonds in the region as part of their portfolios
The reasons investors choose to hold bonds are split between macro points (that is: why hold bonds at all) and micro points (why hold specific bonds from specific issuers). Before we look at the region's bond markets, we perhaps need to take a look at what bonds are and how they work.
Bonds function essentially like a loan, where you, as investor, lend money to the borrower, called the "issuer" of the bond. Governments and corporations both need to issue bonds, whether they are raising money for expansion, such as a new factory, or, in the case of a government, a new infrastructure project. In this respect, bonds are launched as a funding source for the issuer, sitting alongside bank loans and the organisation's cash reserves.
Of course, this "loan" needs to be repaid eventually, and bonds are issued with a specific maturity date, spelling out exactly when the investor will be repaid. This is one of the reasons they are called "fixed-income" -- investors know the amount of cash they will get back if they hold the bond until maturity.
This means that investors do not just get a chance to invest in bonds from a specific issuer, but can invest in the issuer's five or 10-year bonds, for instance. And investors do not need to hold them until maturity. Many -- if not most -- regional investors choose to trade these bonds in the "secondary" market; buying and selling bonds for profit.
But why should investors look to hold bonds as part of their portfolio at all? Perhaps the prime reason is the perceived level of risk when compared to equity stocks. Bonds represent debt, and stocks represent equity ownership so they are treated very differently if there's a default. When we look at who gets paid back first, debt holders have priority over shareholders.
This means that in a worst-case scenario -- such as bankruptcy -- it might well be that after bondholders have been paid out, equity shareholders face losing their entire investment. Of course, if the default was severe, and assets low, there's even a risk bondholders are impacted. But in general bondholders remain insulated by a buffer of equity holders. This is, of course, not to say that investors should not hold equities: many provide a dividend, and equities have historically proven an effective method of growing capital over the long term and protecting against inflation. Rather, investors should be aware of the opportunities presented by bonds.
Second, as "fixed income" many bonds offer investors a set coupon, reliably and regularly paid under the terms of the bonds, differing from the floating rate of any equity dividend. This means that any investors who chose to hold the bonds until their maturity at least get paid for doing so.
When we look at how investors hold bonds, many choose to do so through bond or sukuk funds. These are specifically designed to provide investors with access to a range of funds on a specific theme -- for instance technology, or real estate. While they provide diversified exposure, as they are often "actively" run, by a fund manager, and there are fees attached to this. However, recently the number of investors buying specific bonds after conducting their own research has massively increased, and volumes have exceeded 2011 levels.
Typically, investors are looking at bonds that they know and understand -- the so-called "national champions". These are household names that give investors a level of comfort in their investment. These are often more liquid, meaning that investors who want to cash out of the bond, find a range of ready investors ready to buy in.
Bringing this to the local context of Egypt, local and foreign investors have been investing in government bonds in Egyptian pounds through the regular Treasury Bonds Auction, and in US dollars through the international capital markets issuance Egypt has successfully undertaken in the past. As local markets mature and stability returns, it is fair to assume that both the government and corporate "national champions" will look at bond markets as an alternative source of financing. A series of investor friendly formats will be available to them: local or foreign currency, different maturities, retail distribution targeted, and many more.
But investment is not limited to regional buyers and sellers. Over the last decade, international investors have shown a clear interest in buying Middle East and North Africa (MENA) issued bonds. Part of the reason for this is the levels of return available in the region, which means that the bonds are particularly attractive to international investors looking for yield.
However, I think this "hunt for yield" is only part of the story. While important, it is more significant that international investors have the confidence to invest in a region they have, perhaps, not even visited. Regional companies issuing bonds have made great steps in improving their transparency and reporting, and this has lifted the reputation of not just the issuer of the specific bond, but the whole region.
Second, it was less than a decade ago that the only regional bond issuers were banks. Over the past five years, we have seen a massive increase in the number, and type, of issuers who have sought to come into the market. From utility companies to regional corporations, issuers have all found willing international buyers for their bonds.
So, the final question needs to be, what is holding the region's bond markets back? Bonds are typically issued in a minimum denomination of $100,000 and above, meaning that retail investors looking to access bond markets may be better served by bond funds.
However, this might not be the problem it first appears to be. First of all, many investors in bonds are affluent and experienced investors, so $100,000 invested in one asset may well just match their other investments. Second, these bonds must be actively traded, so investors can trade in and out of specific bonds, matching the needs of their overall investment strategy.
It is therefore clear that bonds are an important option for regional and international investors, whether they are seeking a regular coupon payment or want to actively trade bonds. But what is more significant is how the range and the depth of bonds offered in the region have increased. They stand as a testament to the maturity and the importance of MENA to international investors, and that's something to be proud of.
The writer is head of global markets at HSBC MENA.