Morgan Stanley Favors Convertibles in Growth Bet: China Credit

The China fund management ventures of Morgan Stanley and Schroders Plc 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 1.4 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 shows. The Shanghai Composite Index of equities tumbled 3.3 percent since the start of February, 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 5.6 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

1.9 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 62, 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 0.3 percent this year to 6.2143 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 slumped 14 basis points to 2.04 percent, as of 12:16 p.m. in Shanghai, exchange data show. The stock trades at 2.97 yuan, versus its conversion price of 3.44. The rate on China Shipbuilding Industry Co.’s 0.5 percent note due June 2018 slid 23 basis points to minus 1.99 percent. The shares trade at

5.18 yuan, above the conversion price of 4.93.

The yield on benchmark 10-year government bonds rose two basis points this year to 3.59 percent as of yesterday, Chinabond data show. It reached 3.61 percent on Jan. 29, the highest since November 2011.

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 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 economy is forecast to expand 8.1 percent this year, a separate survey showed.

Data has been mixed so far this year. Industrial production rose 9.9 percent in the last two months, the slowest growth for the period since 2009, and retail sales increased 12.3 percent, 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 most 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 increases 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.”

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