Gangnam Rich Ditching Korea Bonds as Record Slide Seen

Ko Jae Pil advised investors in an upscale area of Seoul to jettison bond funds last year as the Federal Reserve prepared to taper its unprecedented stimulus.

Debt funds no longer figure among investments recommended by the team head of Hana Bank’s private banking branch in the Gangnam neighborhood made famous by rapper Psy’s viral music video “Gangnam Style.” Ko now favors local stock funds with strategies that bet on both gains and losses.

President Park Geun Hye’s plans to spur Asia’s fourth-largest economy with incentives for innovation and tax benefits for service industries are encouraging investors to shift asset allocations. The equivalent of $630 million flowed out of bond funds in the past eight months. The 10-year sovereign yield will rise for a second consecutive year for the first time in data going back to December 2000, a Bloomberg survey shows.

“No one has shown interest in bond funds recently,” Ko, who advises clients with at least 500 million won ($466,000) in financial assets, said in a Feb. 24 interview. “Local interest rates are low. There is little possibility of capital gain.”

The benchmark 10-year yield will climb 39 basis points to 3.90 percent by end-December, according to the median forecast in the survey of seven analysts. The yield, which rose 43 basis points to 3.59 percent in 2013, has fallen seven basis points this year, data compiled by Bloomberg show.

Rates Outlook

A Bloomberg poll shows 13 out of 26 economists predict the Bank of Korea will increase its benchmark interest rate at least once in 2014. Two forecast a cut to 2.25 percent, while the rest expect borrowing costs to be held at 2.5 percent. The Fed has reduced its monthly bond buying by $20 billion to $65 billion this year as the world’s largest economy recovers.

South Korea’s currency weakened 0.4 percent today to 1,068.97 per dollar at the close in Seoul, after posting the biggest gain in two weeks yesterday. Analysts surveyed by Bloomberg News predict the won will strengthen to 1,054 by year-end. Overseas investors increased holdings of won-denominated bonds by 655 billion won in January, the first inflow since July, Financial Supervisory Service said in a Feb. 6 statement.

“We held a long view on Korean bonds for a few years, but have reduced those bets and now have a neutral position,” Lim Han Kyu, who helps manage the equivalent of $11.3 billion as the head of fixed-income, currency, commodities trading at Woori Investment & Securities Co., said in a Feb. 19 interview. “We try to hedge more to minimize losses when rates rise.”

The Bank of Korea will face pressure to increase borrowing costs as the Fed’s tapering continues, Tom Byrne, an analyst at Moody’s Investors Service, told reporters in Seoul Feb. 20. The monetary authority said Jan. 9 it expects gross domestic product to increase 3.8 percent in 2014, the most in four years.

China, U.S.

That outlook has been tempered by disappointing data from the world’s two largest economies. China, which accounted for 26 percent of South Korea’s exports last year, may see slower manufacturing growth for a second month in February, a preliminary gauge released by HSBC Holdings Plc and Markit Economics showed Feb. 20. The latest U.S. data show employment gains in January fell short of forecasts and housing starts slumped amid the harshest winter in two decades.

“The recent soft-patch in data has dented overall optimism on the economic recovery and has seen a reversal from the rising yield trend since second half of 2013,” Wee-Khoon Chong, the Singapore-based head of rates strategy Asia ex-Japan at Nomura, said in a Feb. 25 e-mail interview. “In the longer-term, we are still with the view for Korean yields to drift higher, with the 10-year government bond yield at 3.90 percent by the year-end.”

Debt Maturing

A record 51.6 trillion won of sovereign debt maturing this year will free up funds for investment, according to KB Asset Management Co., which oversees 15 trillion won of debt. Redemptions will be almost twice the level seen in 2010. The finance ministry said in December plans to sell 97.5 trillion won of bonds this year, 10 percent more than the 88.4 trillion won issued in 2013.

“The large amount of debt maturing this year bodes well as cash can be re-invested in Korean bonds,” Moon Dong Hoon, managing director of KB Asset’s fixed-income division in Seoul, said in a Feb. 24 interview. “The economy doesn’t improve without ups and downs, and we don’t know what will happen in China.”

Mutual Funds

Assets of mutual funds specializing in local debt have declined by 671 billion won ($630 million) from a seven-year high of 10.1 trillion won in May, data from Korea Financial Investment Association show. Those of vehicles focusing on money markets and a mix of equity and debt have increased by 1.6 trillion won to 80.5 trillion won in the same period.

South Korea will aim to boost its potential growth rate to 4 percent by 2017, President Park said in a Feb. 25 speech outlining her administration’s economic plan for the next three years. Exports will increase 6.4 percent this year, the most since 2011, the trade ministry predicted in a Jan. 1 statement.

“Recent data from the U.S. and China have been weak, but with little possibility of the global economy faltering in the second half, yields will move higher,” Kim Youngsung, a Seoul-based team head for fixed-income trading at Samsung Asset Management Co., which oversees 130 trillion won as the nation’s biggest fund manager, said in a Feb. 24 interview. Investors aren’t buying debt aggressively and are adopting a wait-and see attitude, he said.

Kim predicts the yield on three-year government bonds, which was steady today at 2.85 percent, may climb above 3 percent in the second half of 2014.

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