Morgan Stanley Favors Convertibles in Growth Bet: China Credit

The China fund management ventures of Morgan Stanley (MS) and Schroders Plc (SDR) are bullish on the nation’s convertible bonds, predicting the world’s second-biggest economy can ride out a stock-market slump.

Chinese debt that can be exchanged into shares lost 1.3 percent in March, set for a second monthly decline, according to the S&P China Convertible Bond Index. Comparable notes in the U.S. gained 2.5 percent, a Bank of America Merrill Lynch index showed. The Shanghai Composite Index (SHCOMP) of equities tumbled 5 percent since Feb. 1, after rising 20 percent in the previous two months, on concern limits on real-estate investment will slow economic growth.

“Even though it’s a weak recovery, those property curbs will make it healthier and more sustainable,” said Lin Hongjun, a Shanghai-based bond fund manager at Bank of Communications Schroders Fund Management Co., which oversees a total of 64.4 billion yuan ($10.4 billion) of assets. “China’s long-term fundamental is good” for convertible bonds this year.

Morgan Stanley Huaxin Fund Management Co. says the combination of the protected returns of a bond and potential for equity-like gains is well-suited to the nation’s “weak” economic rebound. China’s leaders announced on March 5 a target of 7.5 percent for growth this year at the annual congress meeting after expansion slowed to 7.8 percent in 2012, the least in 13 years.

Holding Gains

Exchangeable bonds have still climbed 5.8 percent this year, after a 7.6 percent rally in January. That beat the 0.8 percent advance in the S&P China Government Bond Index and the 1.8 percent gain in the S&P China Corporate Bond Index.

Confidence in China’s economy is improving. Five-year credit-default swaps protecting sovereign notes against non- payment fell five basis points last month to 64 in New York and were recently at 63, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market. The yuan gained 0.2 percent this year to 6.2155 per dollar in Shanghai.

“Convertible bonds are worth investing in this year,” said Hong Tianyang, a Shenzhen-based bond fund manager at Morgan Stanley Huaxin, which oversees 13.2 billion yuan of assets. “There is a big probability that we will have a weak recovery, mild inflation and moderately loose liquidity this year, which is good for both stocks and bonds, especially convertible bonds.”

Earnings Outlook

The yield on Bank of China Ltd.’s 1.1 percent convertible bond due June 2016 has risen 33 basis points this month to 2.18 percent, according to exchange data. The stock trades at 2.94 yuan, versus its conversion price of 3.44. The rate on China Shipbuilding Industry Co.’s 0.5 percent note due June 2018 climbed 77 basis points to minus 1.75 percent, exchange data showed. That reflects a share price of 5.07 yuan that is above the conversion price of 4.93.

Yields on benchmark 10-year government notes have risen 2 basis points this year to 3.59 percent as of March 13, after climbing to as high as 3.61 percent on Jan. 29.

Morgan Stanley Huaxin’s Hong prefers convertible bonds issued by banks because of their good earnings outlook. He also likes military suppliers because their stock prices are volatile, increasing the value of the exchange option.

China Minsheng Banking Corp (600016) will sell 20 billion yuan of six-year convertible bonds today, according to a statement to the Shanghai Stock Exchange on March 12. Guotai Junan Securities Co. estimated that the sale may draw bids worth about 450 billion yuan.

Minsheng Sale

“Demand for the Minsheng convertible will be strong,” said Zhang Yongmin, Beijing-based executive president of the asset management department at Qilu Securities Co. “The U.S. economy is stabilizing and Europe’s will stabilize soon, which will help China’s rebound. Stocks will rise, and so will convertible bonds.”

China’s exports climbed 21.8 percent in February from a year earlier, the customs bureau said on March 8. That compared with a median estimate of 8.1 percent in a Bloomberg News survey. The nation’s economy will grow 8.1 percent this year, according to the median of 45 estimates in a Bloomberg survey.

Data for last month was mixed. Industrial production rose 9.9 percent in the first two months of this year and retail sales increased 12.3 percent, the lowest in the same period since 2009, official data showed on March 9.

Electricity consumption in January and February climbed 5.5 percent from a year earlier, the National Energy Administration said yesterday. Growth was 6.7 percent in the first two months of last year and 12.3 percent in 2011.

Slower Recovery

“The economy is recovering at a slower pace than expected,” said Wang Shen, a bond analyst at Sinolink Securities Co. in Shanghai. “We should be cautious on convertible bonds and stocks through April, even though their performance will be better than bonds this year.”

Consumer prices climbed 3.2 percent in February, the fastest pace in 10 months, the statistics bureau said on March 9. The government’s annual target is 3.5 percent this year, down from 4 percent in 2012. Bocom Schroders’ Lin said inflation “won’t be a problem” in the first half and may drop to 2.5 percent in March.

Morgan Stanley Huaxin’s Hong said the limited number of convertible bonds also increase the securities’ attractiveness. There are about 120 billion yuan of convertible bonds outstanding, according to Guotai Junan Securities.

“While there are 2,400 stocks, only more than 20 convertible bonds are traded,” said Morgan Stanley Huaxin’s Hong. “On one hand, the number of convertibles is still decreasing because some debt will be converted into stocks. On the other hand, most local funds can buy convertible bonds. This imbalance in demand and supply adds value to convertibles.”

--Judy Chen. Editors: Robin Ganguly, Sandy Hendry

To contact the Bloomberg news staff on this story: Judy Chen in Shanghai at xchen45@bloomberg.net.

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