HSBC Shifts Funds From Emerging Markets to Developed Nations as Rates Rise

HSBC Private Bank is shifting funds to shares in developed nations and cutting holdings of bonds and stocks in emerging markets, predicting asset prices will drop as much as 10 percent as developing nations raise interest rates.

“Emerging markets will underperform for another six months,” Arjuna Mahendran, Singapore-based head of investment strategy for Asia at the unit of Europe’s largest bank, said in an interview yesterday. “We’ve been investing in the U.S. and Europe for the last three months because we feel the risk return trade-off is better.”

Shares in the U.S. and Europe are outperforming China and India so far this year as policy makers in developed markets keep interest rates low to revive economies reeling from the worst slump since the Great Depression. Central banks in Asia, which is leading the global recovery, are starting to raise borrowing costs to prevent overheating and slow inflation.

The view of HSBC Private Bank, which controls assets of $460 billion globally, contrasts with that of Pacific Investment Management Co., manager of the world’s biggest bond fund. Pimco recommended investors buy emerging-market bonds rather than debt of developed countries because advanced economies are headed for slower growth, bogged down by higher taxation and regulations.

India has increased borrowing costs twice in 2010 and China in February ordered banks to set aside a bigger portion of deposits as reserves for a second time this year. Australia, Malaysia and Vietnam have also raised interest rates. In contrast, monetary policy in the U.S., Europe and Japan is “very loose and inflation is very low,” said Mahendran.

‘Further Correction’

China’s CSI 300 Index of shares has declined 11 percent this year, following a 97 percent rally in 2009. India’s Bombay Stock Exchange Sensitive Index is up 1.2 percent, after last year’s 81 percent gain. The Standard & Poor’s 500 index of U.S. equities has climbed 8 percent and the Stoxx Europe 600 Index advanced 4.5 percent.

“I expect there will be a correction in emerging-market stocks and bonds,” Mahendran said. Monetary tightening “will take money off the table and have an impact on stock markets.”

Demand for higher-yielding bonds in emerging markets has driven down the premiums investors demand to hold the debt. The difference in yield over U.S. Treasuries shrank to 2.45 percentage points yesterday, approaching a December 2007 low of 2.21 percentage points, according to the EMBI Plus Index compiled by JPMorgan Chase & Co.

‘Spread Compression’

“The spread compression will peak at some point,” said Mahendran, adding that he will then sell emerging-market bonds maturing in seven to 10 years. “I will watch for an opportunity.”

Central banks in the U.S., Europe and Japan have kept interest rates at near-zero to one percent, compared with 3.75 percent in India, 6.5 percent in Indonesia and 4 percent in the Philippines.

Emerging-market bond funds have attracted $11.6 billion this year, compared with the previous all-time high of $9.7 billion set in 2005, according to Massachusetts-based EPFR Global, which tracks $13 trillion in assets globally

Mahendran said he favored debt in Russia, the world’s largest energy exporter, because its central bank cut interest rates for the 12th time in less than a year.

“Russia is seeing remarkably low inflation rates, compared with China, Brazil and India,” Mahendran said. “Within the BRICs, Russia is smelling roses because oil prices are going up and Russia is directly dependent on oil prices.”

To contact the reporters on this story: Lilian Karunungan in Singapore at lkarunungan@bloomberg.net.

The Russian flag flies atop Russia's central bank in Moscow, on Dec. 22, 2009. Photographer: Alexander Zemlianichenko Jr/Bloomberg